Class 11th depreciation

Class 11th depreciation

Depreciation can be defined as the share of the total asset that has been consumed by the company over a certain period of given time. The total number of profit and loss statement of depreciation is based on the usefulness of the fixed assets used in the accounting year.

Following are the 3 principal features of depreciation:

• Depreciation is a decrease in the book value of fixed assets.

• Depreciation is an ongoing process until the end of the life of assets.

• Depreciation involves loss of value of assets due to the passage of time and obsolescence.

Causes of Depreciation

• Wear and Tear due to Use or Passage of Time: Wear and tear is nothing but deterioration and the following decrease in the value of an asset, resulting from its use in business operations for earning revenue.

• Expiration of Legal Rights: Some categories of assets lose their value after the agreement directing their use in business comes to an end after the expiry of the predetermined period.

• Obsolescence: Obsolescence is another factor driving to the depreciation of fixed assets. In common language, obsolescence means being “out-of-date”. Obsolescence refers to an actual asset becoming outdated on account of the availability of a better type of asset.

Causes of Depreciation

• Abnormal Factors: Drop in the use of the asset may be caused by abnormal factors. Namely, accidents due to the earthquake, fire, floods, etc., Accidental loss is permanent but not continuing.

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Depreciation Formula:

• Annual amount of depreciation under SLM

  Annual Depreciation      = ......................................................................................  OrigionalCost−Estimated Scrap Value _______________________________________________ Estimated Useful Life

•  Rate of depreciation on original cost

  Rate of depreciation =  Annual depreciation _______________________________ X 100 ................................................Original cost of asset

Straight Line Method (SLM)

Under the depreciation Straight Line Method, a fixed depreciation amount is charged annually, during the lifetime of an asset. The amount of annual depreciation is computed on Original Cost and it remains fixed from year to year. This method is also known as the ‘Original Cost method’ or ‘Fixed Installment method’.

Written Down Value Method (WDV)

Under the Written Down Value method, depreciation is charged on the book value (cost –depreciation) of the asset every year. Under the WDV method, book value keeps on reducing so, annual depreciation also keeps on decreasing. This method is also known as ‘Diminishing Balance Method’ or ‘Reducing Installment Method’.

Causes

• By Constant Use- When the fixed assets like a motor vehicle, machinery are used for a good amount of time, it manages to wear out

• By Expiry of Time- Due to natural calamities or elements of nature land may start to erode. Similarly, the machinery particles might start rusting

• Outdated Technology- The machine and the technology used today might be outdated and might have to be discarded

• Increase in production- The existing vehicle or machine used is not capable of taking bulk orders

• By Depletion- Exhaustion of resources due to its constant use.

Importance of Depreciation

• For Ascertaining the True Profit or Loss- The true profit of a company can be determined only when all the cost acquired is used to earn revenues is debited to the profit and loss account.

• Showing Correct Financial Status- When the depreciation is not imposed, the asset is recorded in the balance sheet at an amount which is excess of their actual value. In this case, the balance sheet does not present the actual financial status of a company.

• To avoid excess payment of Income Tax- Here, if the depreciation is not subtracted to profit and loss account, the net profit shown will be surplus to the actual profit. Therefore, the company will have to pay extra income tax.

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Meaning of Reserve

Reserves refer to the amount that is set aside out of profits and other surpluses to meet future uncertainties. In other words, a reserve is meant for meeting any sort of an unknown liability or losses in the future.

Types of Reserve

Revenue Reserve- The share of the profits which is not paid to the owner or shareholders,and is kept reserved for operations or other demands, is known as a revenue reserve

General Reserve- Reserve which is kept for nothing specific, but for growing the financial status of a company is known as a general reserve.

Meaning of Provision

The amount retained by way of providing for any unknown liability of which the amount cannot be detained with substantial accuracy.

Provision is arranged to meet a known liability.

Provision is a charge against profit and as such reduces the profits of the year in which it is created.

The liability is known but the amount of these liabilities cannot be ascertained with reasonable accuracy.