Depreciation, Provisions and Reserves Class 11: Methods, Ledger and Reserves

What Depreciation, Provisions and Reserves is about

Weightage: This chapter is part of Unit 2, Accounting Process (Part A: Financial Accounting-I), which carries 44 of the 80 theory marks in the school annual exam together with Recording of Transactions - I, Recording of Transactions - II, Bank Reconciliation Statement and Trial Balance and Rectification of Errors.Source: CBSE Accountancy (055) syllabus 2026-27, Class XI course structure, Unit 2 Accounting Process

Key concepts

Meaning and features of depreciation

NCERT section 7.1

Depreciation is the decline in the value of a fixed (depreciable) asset due to use, passage of time or obsolescence, and the accounting process of allocating the cost of that asset over its useful life.

Features:

• It is a decline in the book value of a fixed asset only (not stock or cash).
• It is a continuing process until the end of the asset's useful life.
• It is an expense (a charge against profit) but non-cash: no cash is paid when it is recorded.
• It is caused by use, time, obsolescence or accidents, not by changes in market price. A rise in the market value of a machine does not stop depreciation.
• It is a process of allocation of cost, not of valuation: the book value after depreciation is not meant to be the market value.

Land is usually not depreciated because it does not wear out or expire (a leasehold land is, over the lease period).

Worked example

Suppose the market price of a delivery van bought for ₹6,00,000 rises to ₹6,50,000 a year later because of inflation. Should depreciation still be charged?

Try it first, then show the solutionSolution

1. Depreciation allocates cost over useful life; it is not a market valuation
2. The van is still being used up and moving towards the end of its life

Answer: Yes. Depreciation is charged regardless of changes in market price.

Depletion, amortisation; causes and need for depreciation

NCERT section 7.2 to 7.4

Related terms:

• Depletion: the reduction in a natural resource (wasting asset) such as a mine, quarry or oil well as it is extracted. It is measured by the quantity taken out.
• Amortisation: writing off the cost of an intangible asset (patent, copyright, trademark, leasehold) over its useful or legal life.

Causes of depreciation:
1. Wear and tear due to use (a machine running every day).
2. Expiry of legal rights (a patent for 20 years, a lease for 10 years).
3. Obsolescence: the asset becomes out of date because of new technology or a change in demand, even if it still works.
4. Abnormal factors: accidents, fire, floods.

Need for depreciation:

• Matching: the cost of using an asset is matched with the revenue it helps earn, so profit is correct.
• True and fair Balance Sheet: assets are shown at cost less depreciation, not at inflated cost.
• Consideration for tax: depreciation is an allowable deduction for income tax.
• Compliance with law: the Companies Act requires companies to provide for depreciation.
• Funds for replacement: profit is reduced, so less is withdrawn or distributed and resources stay in the business.

Worked example

Name the term used for: (a) writing off the cost of a 10-year franchise; (b) the reduction in a coal mine as coal is dug out; (c) a typewriter replaced because computers arrived.

Try it first, then show the solutionSolution

1. (a) Intangible asset over its life: amortisation
2. (b) Natural resource used up: depletion
3. (c) Out of date though working: obsolescence (a cause of depreciation)

Answer: (a) Amortisation; (b) depletion; (c) obsolescence.

Factors affecting the amount of depreciation

NCERT section 7.5

1. Cost of the asset: purchase price plus all costs to bring it to working condition (freight, installation, registration, trial-run expenses). GST that can be claimed as input tax credit is not part of cost.
2. Estimated useful life: the period (or number of units, or hours) for which the asset will be used by the business, which may be shorter than its physical life.
3. Estimated net residual (scrap) value: the amount expected on disposal at the end of its useful life, less the costs of disposal.

The depreciable cost is cost minus net residual value.

For example, a bakery oven: price ₹1,80,000, freight ₹8,000, installation ₹12,000, so cost ₹2,00,000; scrap value ₹20,000; useful life 8 years. Depreciable cost = ₹1,80,000.

Worked example

A machine is bought for ₹4,50,000; transport ₹15,000 and installation ₹35,000 are paid; it is expected to be sold for ₹50,000 after 10 years. Find the cost and depreciable cost.

Try it first, then show the solutionSolution

1. Cost = 4,50,000 + 15,000 + 35,000 = ₹5,00,000
2. Depreciable cost = 5,00,000 − 50,000 = ₹4,50,000

Answer: Cost ₹5,00,000; depreciable cost ₹4,50,000.

Straight Line Method (SLM)

NCERT section 7.6

Under the Straight Line Method (fixed instalment or original cost method), an equal amount is charged every year:

Annual depreciation = (Cost − Net residual value) ÷ Estimated useful life

Rate of depreciation (%) = Annual depreciation ÷ Cost × 100

If the rate is given, depreciation = Cost × Rate. For part of a year, multiply by months used ÷ 12 (count from the date of purchase or to the date of sale).

Advantages: simple to understand and apply; the asset can be written down to exactly its scrap value; suits assets that give equal service every year (furniture, leasehold, patents).
Limitations: ignores that repairs rise as the asset ages, so the total charge (depreciation + repairs) rises over time; ignores interest on capital; the book value can reach zero while the asset is still in use; not accepted for income tax in most cases.

Worked example

Find the annual depreciation and rate for the bakery oven: cost ₹2,00,000, scrap ₹20,000, life 8 years.

Try it first, then show the solutionSolution

1. Annual depreciation = (2,00,000 − 20,000) ÷ 8 = ₹22,500
2. Rate = 22,500 ÷ 2,00,000 × 100 = 11.25%

Answer: ₹22,500 a year; rate 11.25% on cost.

Written Down Value Method (WDV) and comparison with SLM

NCERT section 7.6 and 7.7

Under the Written Down Value Method (diminishing balance or reducing balance method), depreciation is charged at a fixed rate on the book value at the start of each year. So the amount falls every year.

Depreciation for the year = Opening book value × Rate (× months/12 for part of a year).

Advantages: heavier charge in early years when repairs are low and lighter later when repairs rise, so the total charge stays more even; suits plant and machinery, vehicles; accepted by income tax law; allows for obsolescence.
Limitations: the asset is never written down to zero; finding a suitable rate is harder; the calculation is longer.

Below, a ₹1,00,000 asset is depreciated at 20% by both methods:

Year	SLM 20% depreciation (₹)	SLM book value (₹)	WDV 20% depreciation (₹)	WDV book value (₹)
Year 1	20,000	80,000	20,000	80,000
Year 2	20,000	60,000	16,000	64,000
Year 3	20,000	40,000	12,800	51,200
Year 4	20,000	20,000	10,240	40,960
Year 5	20,000	0	8,192	32,768

Basis	SLM	WDV
Depreciation charged on	Original cost	Book value at the start of each year
Amount each year	Same	Falls every year
Book value at the end of life	Can become zero or scrap value	Never becomes zero
Suited to	Furniture, patents, leasehold	Plant, machinery, vehicles
Recognised by income tax	Generally no	Yes
Total charge with repairs	Rises over time	More even

Worked example

A machine costing ₹2,00,000 is depreciated at 15% WDV. Find depreciation for the first three years and the book value at the end of Year 3.

Try it first, then show the solutionSolution

1. Year 1: 15% of 2,00,000 = ₹30,000; book value ₹1,70,000
2. Year 2: 15% of 1,70,000 = ₹25,500; book value ₹1,44,500
3. Year 3: 15% of 1,44,500 = ₹21,675; book value ₹1,22,825

Answer: Depreciation ₹30,000, ₹25,500 and ₹21,675; book value ₹1,22,825.

Methods of recording depreciation

NCERT section 7.8

Method 1: charging depreciation to the asset account. The asset account is credited each year, so it shows the book value (written down value).

Particulars	Dr (₹)	Cr (₹)
Depreciation A/c ... Dr	25,000
To Machinery A/c		25,000
(Depreciation charged for the year)
Profit and Loss A/c ... Dr	25,000
To Depreciation A/c		25,000
(Depreciation transferred to P&L)

Method 2: creating a provision for depreciation (accumulated depreciation) account. The asset account stays at original cost year after year; depreciation is credited to a separate Provision for Depreciation A/c, which builds up the total depreciation to date.

Particulars	Dr (₹)	Cr (₹)
Depreciation A/c ... Dr	25,000
To Provision for Depreciation A/c		25,000
(Depreciation provided for the year)
Profit and Loss A/c ... Dr	25,000
To Depreciation A/c		25,000
(Depreciation transferred to P&L)

In the Balance Sheet under Method 2, the asset is shown at cost less the provision for depreciation (accumulated depreciation), so a reader sees both the original cost and the depreciation to date.

Basis	Charging to asset account	Provision for depreciation account
Asset account shows	Written down value	Original cost
Accumulated depreciation	Not shown separately	Shown in a separate account
Information in the Balance Sheet	Only book value	Cost, accumulated depreciation and book value

Worked example

Under Method 2, a machine costing ₹3,00,000 has accumulated depreciation of ₹90,000. How is it shown in the Balance Sheet?

Try it first, then show the solutionSolution

1. Asset at cost ₹3,00,000
2. Less: provision for depreciation ₹90,000
3. Net ₹2,10,000

Answer: Machinery ₹3,00,000 − Provision for depreciation ₹90,000 = ₹2,10,000.

Disposal of an asset and additions to existing assets

NCERT section 7.9 and 7.10

When an asset is sold (or scrapped):
1. Charge depreciation on it up to the date of sale.
2. Find its book value on that date.
3. Profit or loss on sale = Sale price − Book value. A loss is debited and a profit credited to the Profit and Loss A/c.

Under Method 1, the depreciation, the sale proceeds and the loss (or the profit on the debit side) all go through the asset account.

Under Method 2, an Asset Disposal A/c is opened:

Particulars	Dr (₹)	Cr (₹)
Asset Disposal A/c ... Dr	2,50,000
To Machinery A/c		2,50,000
(Cost of Machine A transferred on sale)
Provision for Depreciation A/c ... Dr	62,500
To Asset Disposal A/c		62,500
(Accumulated depreciation on Machine A transferred)
Bank A/c ... Dr	1,50,000
To Asset Disposal A/c		1,50,000
(Sale proceeds of Machine A)
Profit and Loss A/c ... Dr	37,500
To Asset Disposal A/c		37,500
(Loss on sale transferred)

The disposal account collects the cost of the asset sold, its accumulated depreciation and the sale price; its balance is the profit or loss.

Additions or extensions: a new asset bought during the year is depreciated only for the months it is in use. An addition that becomes part of an existing asset (an extension to a building) is depreciated over the remaining life of the main asset or its own life, whichever is shorter. Repairs that only maintain the asset are revenue expenses, not additions.

Worked example

Under SLM at 10%, Machine A (cost ₹2,50,000, bought 1st July 2023) is sold on 31st December 2025 for ₹1,50,000. Find the profit or loss.

Try it first, then show the solutionSolution

1. Depreciation: 2023-24 (9 months) ₹18,750; 2024-25 ₹25,000; 2025-26 (9 months) ₹18,750; total ₹62,500
2. Book value = 2,50,000 − 62,500 = ₹1,87,500
3. Loss = 1,87,500 − 1,50,000 = ₹37,500

Answer: Loss on sale ₹37,500.

Provisions

NCERT section 7.11

A provision is an amount charged against profit to provide for a known liability or a likely loss whose amount cannot be determined with certainty. "Charged against profit" means it is debited to the Profit and Loss Account before finding the net profit, whether there is a profit or not.

Examples: provisions for tax, for doubtful debts, for depreciation, for discount on debtors, and for repairs and renewals.

Importance: it follows the conservatism (prudence) concept and the matching concept; it ensures that profit is not overstated and that the Balance Sheet shows assets at realistic values (debtors less provision) or includes expected liabilities (provision for tax).

Accounting: Profit and Loss A/c Dr; To Provision for ... A/c. In the Balance Sheet, a provision is either deducted from the asset concerned (provision for doubtful debts from debtors) or shown on the liabilities side (provision for tax).

Worked example

Debtors are ₹2,00,000 and 5% are expected to be doubtful. Show the provision and its effect.

Try it first, then show the solutionSolution

1. Provision = 5% of 2,00,000 = ₹10,000
2. Profit and Loss A/c Dr 10,000; To Provision for Doubtful Debts A/c 10,000
3. Balance Sheet: Debtors 2,00,000 − 10,000 = ₹1,90,000

Answer: Provision ₹10,000; profit falls by ₹10,000; debtors shown at ₹1,90,000.

Reserves: types, difference from provisions, secret reserve

NCERT section 7.12 and 7.13

A reserve is a part of profit set aside (appropriated) to strengthen the financial position, meet unknown future needs or for a specific purpose. It is an appropriation of profit, made only after net profit is found, and only if there is a profit. It is shown under Reserves and Surplus (with capital) on the liabilities side.

Types of reserves:

• Revenue reserve: created out of revenue profits (from normal operations). It can be used for any purpose, including dividends.
• General reserve: not for any specific purpose; strengthens the business (also called free reserve).
• Specific reserve: for a particular purpose, e.g. dividend equalisation reserve, debenture redemption reserve, investment fluctuation reserve.
• Capital reserve: created out of capital profits (not from normal trading): premium on issue of shares or debentures, profit on sale of fixed assets, profit on revaluation, profit on reissue of forfeited shares, profit made before incorporation. It is generally not available for dividends and is used to write off capital losses.
• Secret reserve: a reserve not shown in the Balance Sheet, created by deliberately understating assets or overstating liabilities (excess depreciation, writing off an asset that still has value, undervaluing stock, excess provision for doubtful debts). It strengthens the business quietly but can be misused to hide information or manipulate profit.

Provision vs reserve:

Basis	Provision	Reserve
Nature	Charge against profit	Appropriation of profit
Purpose	Known liability or expected loss	Strengthen position or unknown needs
Made when	Even if there is a loss	Only if there is a profit
Shown	Deducted from the asset or as a liability	Under reserves and surplus
Dividend	Cannot be used	Revenue reserves can be distributed

Capital reserve vs revenue reserve: source (capital profits vs revenue profits), purpose (usually laid down by law vs any purpose), use for dividend (not allowed vs allowed).

Worked example

A company earns a net profit of ₹4,00,000 and transfers 10% to general reserve. It also earns ₹60,000 premium on issue of shares. Classify both and give the amounts.

Try it first, then show the solutionSolution

1. General reserve = 10% of 4,00,000 = ₹40,000: a revenue reserve, an appropriation of profit
2. Securities premium of ₹60,000 is a capital profit: a capital reserve

Answer: General reserve ₹40,000 (revenue reserve); ₹60,000 premium (capital reserve).

Depreciation, Provisions and Reserves in real life

Each concept, met in an everyday situation. Read the situation, answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Topics in this chapter

• Disposal of an Asset: Provision for Depreciation and Asset Disposal Account
• Depreciation by the Straight Line and Written Down Value Methods

Depreciation, Provisions and Reserves: key facts

Cost of an asset

Cost = Purchase price + Freight + Installation + Other costs to make it ready for use

Recoverable GST is not part of cost.

SLM annual depreciation

Depreciation = (Cost − Net residual value) ÷ Useful life

Same amount each year.

SLM rate

Rate % = Annual depreciation ÷ Cost × 100

If the rate is given: Depreciation = Cost × Rate.

WDV depreciation

Depreciation = Opening book value × Rate

Falls every year; never reaches zero.

Part-year depreciation

Depreciation = Annual amount × Months used ÷ 12

From purchase to year-end, or from year-start to sale.

Book value after n years (WDV)

Book value = Cost × (1 − r)^n

For full years only.

Profit or loss on sale

Profit (loss) = Sale price − Book value on the date of sale

Debit loss, credit profit to the P&L Account.

Balance Sheet (Method 2)

Net book value = Asset at cost − Provision for depreciation

Both figures are shown.

How the school exam asks Depreciation, Provisions and Reserves

The question patterns to expect, and the method that works for each.

Tricks to remember Depreciation, Provisions and Reserves

Short memory aids. Say each one aloud once, then use it on a question the same day.

• Factors: "CLR"

  Cost, Life, Residual value decide depreciation.

  Use it when: Factors affecting depreciation.

• Causes: "WEOA"

  "We Eat Only Apples": Wear and tear, Expiry of legal rights, Obsolescence, Accidents.

  Use it when: Causes of depreciation.

• SLM vs WDV

  SLM: Same Little Money each year; WDV: Weaker Depreciation each Year.

  Use it when: Comparing the methods.

• Provision vs reserve

  Provision: Profit and loss is charged; Reserve: Retained from profit.

  Use it when: Any provision/reserve distinction.

Depreciation, Provisions and Reserves: exam-level solved questions

Ordered from exam level to HOTS. Cover the solution, write your own, then compare step by step.

Case-study practice (Section E style)

Read the situation, then answer every part. In a school exam set on the board pattern this is a 4-mark question split into 1 + 1 + 2 marks.

Where the marks are

How a typical answer is split into step marks. Show every step: a right final answer alone rarely earns full marks.

Where students lose marks in Depreciation, Provisions and Reserves

The slips examiners see most often, and what to write instead.

• ✗Mistake: Charging a full year's depreciation on an asset bought or sold during the year

  Ignoring the dates in the question.

  Wrong working

  Machine bought 1st October: 10% × 1,20,000 = ₹12,000 in the first year

  Right working

  10% × 1,20,000 × 6/12 = ₹6,000

  ✓Do this: Count months from purchase to 31st March, or from 1st April to the date of sale.

  Usually costs: 1-2 marks and every later balance.

• ✗Mistake: Using cost instead of book value under WDV

  Mixing the two methods.

  Wrong working

  Year 2 depreciation = 20% of 2,50,000

  Right working

  Year 2 depreciation = 20% of 2,12,500 (book value)

  ✓Do this: WDV is always on the opening book value.

  Usually costs: 1 mark per year.

• ✗Mistake: Leaving installation and freight out of cost

  They are paid separately.

  ✓Do this: Add every cost of making the asset ready for use before computing depreciation.

  Usually costs: All depreciation figures; 2 marks.

• ✗Mistake: Forgetting depreciation up to the date of sale

  Students go straight to sale price minus book value at the last year-end.

  Wrong working

  Loss = 2,06,250 (book value on 31st March 2025) − 1,50,000 = ₹56,250

  Right working

  Charge 9 months' depreciation first: book value 1,87,500; loss ₹37,500

  ✓Do this: Always depreciate up to the sale date before finding profit or loss.

  Usually costs: 1-2 marks.

• ✗Mistake: Calling a reserve a charge against profit

  Both are "set aside".

  ✓Do this: Provision = charge (before profit, even in a loss); reserve = appropriation (after profit, only from profit).

  Usually costs: 1 mark in a distinction.

• ✗Mistake: Crediting the asset account with depreciation under Method 2

  Habit from Method 1.

  ✓Do this: Under the provision method, the asset stays at cost; credit Provision for Depreciation A/c.

  Usually costs: 1-2 marks in the account.

NCERT exercise guide: Depreciation, Provisions and Reserves

What each exercise in the NCERT chapter tests, how to approach it, and a question of the same kind solved step by step. Questions here are written in our own words.

Practice questions on Depreciation, Provisions and Reserves

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

1. Q1 · 1 mark · MCQExam level

   Under the written down value method, depreciation:
   (a) is the same every year
   (b) increases every year
   (c) decreases every year
   (d) is charged on cost

   Hint

   Rate × falling book value.

   Answer

   (c) decreases every year

2. Q2 · 1 mark · MCQExam level

   Premium received on issue of shares is credited to a:
   (a) general reserve
   (b) capital reserve
   (c) secret reserve
   (d) provision

   Hint

   A capital profit.

   Answer

   (b) capital reserve (securities premium)

3. Q3 · 1 mark · Very short answerExam level

   Name the term for writing off the cost of a patent over its life.

   Hint

   Intangible asset.

   Answer

   Amortisation.

4. Q4 · 3 marks · Short answerExam level

   Explain any three causes of depreciation.

   Hint

   Use, time, technology.

   Answer

   (1) Wear and tear from use. (2) Expiry of legal rights (lease, patent) with the passage of time. (3) Obsolescence: newer technology or changed demand makes the asset out of date. (Also accidents.)

5. Q5 · 3 marks · Short answerHarder exam level

   A machine costing ₹1,50,000 is bought on 1st October 2025. Find depreciation for 2025-26 (year ending 31st March) at 12% p.a. by (a) SLM and (b) WDV.

   Hint

   Six months in the first year.

   Answer

   (a) 1,50,000 × 12% × 6/12 = ₹9,000. (b) Also ₹9,000 in the first year, since book value = cost; the methods differ from the second year.

6. Q6 · 6 marks · Long answerHarder exam level

   Suppose Kohli Transport buys Van X on 1st July 2024 for ₹6,00,000 and Van Y on 1st October 2025 for ₹4,00,000. Van X is sold on 31st December 2025 for ₹4,20,000. Depreciation is charged at 20% p.a. by the written down value method; accounts close on 31st March. Prepare the Vans account for 2024-25 and 2025-26.

   Hint

   Van X: 9 months in each year; Van Y: 6 months.

   Answer

   Vans Account (year ended 31st March 2025)

   Date	Particulars (Dr)	₹	Date	Particulars (Cr)	₹
   1 Jul 2024	To Bank A/c (Van X)	6,00,000	31 Mar 2025	By Depreciation A/c (Van X, 9 months)	90,000
   			31 Mar 2025	By Balance c/d	5,10,000
   	Total	6,00,000		Total	6,00,000

   Vans Account (year ended 31st March 2026)

   Date	Particulars (Dr)	₹	Date	Particulars (Cr)	₹
   1 Apr 2025	To Balance b/d	5,10,000	31 Dec 2025	By Depreciation A/c (Van X, 9 months)	76,500
   1 Oct 2025	To Bank A/c (Van Y)	4,00,000	31 Dec 2025	By Bank A/c (sale of Van X)	4,20,000
   			31 Dec 2025	By Profit and Loss A/c (loss on sale)	13,500
   			31 Mar 2026	By Depreciation A/c (Van Y, 6 months)	40,000
   			31 Mar 2026	By Balance c/d	3,60,000
   	Total	9,10,000		Total	9,10,000

   Van X book value on sale ₹4,33,500; loss ₹13,500.

7. Q7 · 4 marks · Short answerHarder exam level

   Suppose Machine P, which cost ₹3,60,000, is sold for ₹2,25,000 by cheque. Depreciation is recorded through a provision for depreciation account, and the accumulated depreciation on Machine P up to the date of sale is ₹1,44,000. Pass the journal entries for the sale.

   Hint

   Four entries through Asset Disposal A/c; compare the sale price with the book value.

   Answer

   Particulars	Dr (₹)	Cr (₹)
   Asset Disposal A/c ... Dr	3,60,000
   To Machinery A/c		3,60,000
   (Cost of Machine P transferred on sale)
   Provision for Depreciation A/c ... Dr	1,44,000
   To Asset Disposal A/c		1,44,000
   (Accumulated depreciation on Machine P transferred)
   Bank A/c ... Dr	2,25,000
   To Asset Disposal A/c		2,25,000
   (Sale proceeds of Machine P)
   Asset Disposal A/c ... Dr	9,000
   To Profit and Loss A/c		9,000
   (Profit on sale transferred)

   Book value ₹2,16,000; profit on sale ₹9,000.

8. Q8 · 4 marks · Short answerHarder exam level

   Distinguish between SLM and WDV on four bases.

   Hint

   Base, amount, book value, suitability.

   Answer

   Base: original cost vs opening book value. Amount: same every year vs decreasing. Book value: can reach zero/scrap vs never zero. Suitability: furniture, patents vs plant, vehicles (also tax recognition: WDV accepted).

9. Q9 · 4 marks · Short answerHarder exam level

   Distinguish between a provision and a reserve on four bases, and give two examples of each.

   Hint

   Charge vs appropriation.

   Answer

   Nature: charge against profit vs appropriation of profit. Purpose: known liability or loss vs strengthening the business. Made when: even in a loss vs only from profit. Dividend: never vs revenue reserves can be distributed. Provisions: depreciation, doubtful debts, tax. Reserves: general reserve, dividend equalisation reserve.

10. Q10 · 4 marks · Short answerHarder exam level

    Suppose a truck bought for ₹10,00,000 is depreciated at 20% WDV. In the third year it is destroyed in an accident on 30th September, and the insurer pays ₹4,50,000. Accounts close on 31st March, and the truck was bought on 1st April two years earlier. Find the loss.

    Hint

    Two full years, then six months.

    Answer

    Year 1: 2,00,000 → 8,00,000. Year 2: 1,60,000 → 6,40,000. Year 3 (6 months): 64,000 → 5,76,000. Loss = 5,76,000 − 4,50,000 = ₹1,26,000 (debited to P&L).

11. Q11 · 6 marks · Long answerHarder exam level

    Explain the meaning of capital reserve and revenue reserve with two examples each, and state how they differ in use.

    Hint

    Source of profit.

    Answer

    Capital reserve: from capital profits, e.g. securities premium, profit on sale of fixed assets, profit on revaluation; generally not available for dividends, used for capital losses or bonus shares. Revenue reserve: from revenue profits of normal operations, e.g. general reserve, dividend equalisation reserve; can be used for any purpose including dividends.

12. Q12 · 4 marks · Long answerHOTS / competency

    Suppose a company's accountant charges 30% depreciation on furniture though its useful life suggests 10%, and values stock well below cost "to be safe". What has he created, what is its effect on this year's profit and the Balance Sheet, and is it acceptable?

    Hint

    Understated assets.

    Answer

    A secret reserve. Profit is understated by the excess depreciation and the stock undervaluation, and assets are understated in the Balance Sheet. Some prudence is allowed, but deliberate understatement misleads shareholders and lenders and can be used to shift profit between years, so it conflicts with a true and fair view and full disclosure.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1. 1.Is depreciation a cash expense?Show answer

   No, it is a non-cash expense.

2. 2.Formula for SLM depreciation?Show answer

   (Cost − Net residual value) ÷ Useful life.

3. 3.Which method never reduces the book value to zero?Show answer

   Written down value method.

4. 4.Which account is opened on the sale of an asset under the provision method?Show answer

   Asset Disposal Account.

5. 5.Give one example of a capital reserve.Show answer

   Securities premium (also profit on sale of fixed assets).

6. 6.What is depletion?Show answer

   Reduction in a natural resource as it is extracted.

7. 7.Is a reserve made in a year of loss?Show answer

   No; reserves come out of profit.

8. 8.What is a secret reserve?Show answer

   A reserve not shown in the Balance Sheet, created by understating assets or overstating liabilities.

Quick revision checklist

The night before the exam: can you do each of these without looking?

• ☐Can you define depreciation and list its features?
• ☐Can you explain four causes and four needs for depreciation?
• ☐Can you tell depreciation, depletion and amortisation apart?
• ☐Can you compute SLM depreciation and rate from cost, scrap and life?
• ☐Can you compute WDV depreciation for three years?
• ☐Can you charge part-year depreciation on purchases and sales?
• ☐Can you find profit or loss on sale of an asset?
• ☐Can you prepare the provision for depreciation and asset disposal accounts?
• ☐Can you distinguish provision and reserve, and capital and revenue reserve?
• ☐Can you explain secret reserve and its risks?

Depreciation, Provisions and Reserves: frequently asked questions