DEPRECIATION , PROVISIONS AND RESERVES.
DEPRECIATION OF FIXED ASSETS.
Fixed assets such as machinery, motor vehicle, furniture and fittings used in business lose their value over a period of time.
Lose in value should be taken into account while calculating Net Profit as failure to do so implies that net profit is overstated and is against the prudence concept.
*Depreciation is the estimated loss in money value of fixed Assets owing to use, obsolete or passage of time. Also means cost of wear and tear of the fixed assets.
*Amortization means provision of extinction of a liability or replacement of an asset normally by means of sinking funds. This are assets which have fixed period of legal life : Leases, patents and copyrights. Provisions created to decrease value of these assets is amortization.
*Depletion: This is a provision created for an asset of wasting character such as mines and quarries. This assets are of wasting character due to extraction of raw materials from them.
METHODS OF CALCULATING DEPRECIATION.
In determining depreciation, the following factors are considered
- The original cost of the asset.
- The expected working/ useful life of the Asset.
- The Estimated value of the asset at the end of working life. (scrap value)
Thus TOTAL DEPRECIATION (i-iii) is normally spread over (ii.)
- Fixed installments or straight line method.
- Reducing balance method.
- Revaluation Method.
TREATMENT OF DEPRECIATION.
Depreciation represents decrease in fixed asset value. Loss in value is chargeable against profits made during the working life of the asset concerned.
Annual depreciation computed using any method is charged to profit of any particular year.
Annual depreciation is treated as follows:
DR; Profit and loss account.
CR; Assets account or provisions for depreciation Account.
Depreciation is always debited to profit and loss account but it may be credited either to asset account or provision for depreciation account. The effect of this depreciation on Asset value will be the same in both cases. However to keep track of the cost of the asset, depreciation is normally credited to a separate account known as provision for depreciation account. Credit balance in the provision for depreciation account is shown as a deduction from cost price of the asset in the balance sheet. The difference represent the net book value or written down value of the asset as at that date of the balance sheet.