NCERRT Chapter 7: Depriciation , Provisions and reserves, Accountancy, Class 11 PDF Download

 Page 1


M
atching principle requires that the revenue of
a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
entire cost as expense in the year in which it is
incurred. In fact, such a cost must be spread over
the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main
subject matter of the present chapter, deals with such
a situation. Further, it may not always be possible
to ascertain with certainty the amount of some
particular expense. Recall the principle of
conservatism (prudence) which requires that instead
of ignoring such items of costs, adequate provision
must be made and charged against profits of the
current period. Moreover, a part of profit may be
retained in the business in the form of reserves to
provide for growth, expansion or meeting certain
specific needs of the business in future. This  chapter
deals with two distinct topics and hence is being
presented in two different sections. First section deals
with depreciation and second section  deals with
provisions and reserves.
SECTION – I
7.1 Depreciation
Now you are aware that fixed assets are the assets
which are used in business for more than one
LEARNING OBJECTIVES
After studying this chapter,
you will be able to :
• explain the meaning of
depreciation and
distinguish it from
amortisation and
depletion;
• state the need for
charging depreciation
and identify its causes;
• compute depreciation
using straight line and
written down value
methods;
• record transactions
relating to depreciation
and disposition of
assets;
• explain the meaning
and purpose of creating
provisions and reserves;
• distinguish between
reserves and provisions;
• explain the nature of
various types of
provisions and reserves
including secret reserve.
Depreciation, Provisions and Reserves 7
© NCERT
not to be republished
Page 2


M
atching principle requires that the revenue of
a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
entire cost as expense in the year in which it is
incurred. In fact, such a cost must be spread over
the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main
subject matter of the present chapter, deals with such
a situation. Further, it may not always be possible
to ascertain with certainty the amount of some
particular expense. Recall the principle of
conservatism (prudence) which requires that instead
of ignoring such items of costs, adequate provision
must be made and charged against profits of the
current period. Moreover, a part of profit may be
retained in the business in the form of reserves to
provide for growth, expansion or meeting certain
specific needs of the business in future. This  chapter
deals with two distinct topics and hence is being
presented in two different sections. First section deals
with depreciation and second section  deals with
provisions and reserves.
SECTION – I
7.1 Depreciation
Now you are aware that fixed assets are the assets
which are used in business for more than one
LEARNING OBJECTIVES
After studying this chapter,
you will be able to :
• explain the meaning of
depreciation and
distinguish it from
amortisation and
depletion;
• state the need for
charging depreciation
and identify its causes;
• compute depreciation
using straight line and
written down value
methods;
• record transactions
relating to depreciation
and disposition of
assets;
• explain the meaning
and purpose of creating
provisions and reserves;
• distinguish between
reserves and provisions;
• explain the nature of
various types of
provisions and reserves
including secret reserve.
Depreciation, Provisions and Reserves 7
© NCERT
not to be republished
228 Accountancy
accounting year. Fixed assets (technically referred to as “depreciable assets”)
tend to reduce their value once they are put to use. In general, the term
“Depreciation” means decline in the value of a fixed assets due to use, passage
of time or obsolescence. In other words, if a business enterprise procures a
machine and uses it in production process then the value of machine declines
with its usage. Even if the machine is not used in production process, we can
not expect it to realise the same sales price due to the passage of time or
arrival of a new model (obsolescence). It implies that fixed assets are subject
to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset
which has expired on account of its usage and/or lapse of time. Hence,
depreciation is an expired cost or expense, charged against the revenue of a
given accounting period. For example, a machine is purchased for Rs.1,00,000
on April 01, 2010. The useful life of the machine is estimated to be 10 years. It
implies that the machine can be used in the production process for next 10
years till March 31, 2015. You know that by its very nature, Rs. 1,00,000 is a
capital expenditure during the year 2010. However, when income statement
(Profit and Loss Account) is prepared, the entire amount of Rs.1,00,000 can not
be charged against the revenue for the year 2010, because of the reason that the
capital expenditure amounting to Rs.1,00,000 is expected to derive  benefits (or
revenue) for 10 years and not one year. Therefore, it is logical to charge only a
part of the total cost say Rs.10,000  (one tenth of   Rs. 1,00,000) against the
revenue for the year 2010. This part represents the expired cost or loss in the
value of machine on account of its use or passage of time and is referred to as
‘Depreciation’. The amount of depreciation, being a charge against profit, is
debited to the Profit  and Loss  Account.
7.1.1 Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual
shrinkage in the book value of fixed assets. It is based on the cost of assets
consumed in a business and not on its market value.
According to Institute of Cost and Management Accounting, London (ICMA)
terminology “ The depreciation is the diminution in intrinsic value of the asset
due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants
of India (ICAI) defines depreciation as “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, effluxion of time or
obsolescence through technology and market-change. Depreciation is allocated
so as to charge fair proportion of depreciable amount in each accounting period
during the expected useful life of the asset. Depreciation includes amortisation
of assets whose useful life is pre-determined”.
© NCERT
not to be republished
Page 3


M
atching principle requires that the revenue of
a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
entire cost as expense in the year in which it is
incurred. In fact, such a cost must be spread over
the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main
subject matter of the present chapter, deals with such
a situation. Further, it may not always be possible
to ascertain with certainty the amount of some
particular expense. Recall the principle of
conservatism (prudence) which requires that instead
of ignoring such items of costs, adequate provision
must be made and charged against profits of the
current period. Moreover, a part of profit may be
retained in the business in the form of reserves to
provide for growth, expansion or meeting certain
specific needs of the business in future. This  chapter
deals with two distinct topics and hence is being
presented in two different sections. First section deals
with depreciation and second section  deals with
provisions and reserves.
SECTION – I
7.1 Depreciation
Now you are aware that fixed assets are the assets
which are used in business for more than one
LEARNING OBJECTIVES
After studying this chapter,
you will be able to :
• explain the meaning of
depreciation and
distinguish it from
amortisation and
depletion;
• state the need for
charging depreciation
and identify its causes;
• compute depreciation
using straight line and
written down value
methods;
• record transactions
relating to depreciation
and disposition of
assets;
• explain the meaning
and purpose of creating
provisions and reserves;
• distinguish between
reserves and provisions;
• explain the nature of
various types of
provisions and reserves
including secret reserve.
Depreciation, Provisions and Reserves 7
© NCERT
not to be republished
228 Accountancy
accounting year. Fixed assets (technically referred to as “depreciable assets”)
tend to reduce their value once they are put to use. In general, the term
“Depreciation” means decline in the value of a fixed assets due to use, passage
of time or obsolescence. In other words, if a business enterprise procures a
machine and uses it in production process then the value of machine declines
with its usage. Even if the machine is not used in production process, we can
not expect it to realise the same sales price due to the passage of time or
arrival of a new model (obsolescence). It implies that fixed assets are subject
to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset
which has expired on account of its usage and/or lapse of time. Hence,
depreciation is an expired cost or expense, charged against the revenue of a
given accounting period. For example, a machine is purchased for Rs.1,00,000
on April 01, 2010. The useful life of the machine is estimated to be 10 years. It
implies that the machine can be used in the production process for next 10
years till March 31, 2015. You know that by its very nature, Rs. 1,00,000 is a
capital expenditure during the year 2010. However, when income statement
(Profit and Loss Account) is prepared, the entire amount of Rs.1,00,000 can not
be charged against the revenue for the year 2010, because of the reason that the
capital expenditure amounting to Rs.1,00,000 is expected to derive  benefits (or
revenue) for 10 years and not one year. Therefore, it is logical to charge only a
part of the total cost say Rs.10,000  (one tenth of   Rs. 1,00,000) against the
revenue for the year 2010. This part represents the expired cost or loss in the
value of machine on account of its use or passage of time and is referred to as
‘Depreciation’. The amount of depreciation, being a charge against profit, is
debited to the Profit  and Loss  Account.
7.1.1 Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual
shrinkage in the book value of fixed assets. It is based on the cost of assets
consumed in a business and not on its market value.
According to Institute of Cost and Management Accounting, London (ICMA)
terminology “ The depreciation is the diminution in intrinsic value of the asset
due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants
of India (ICAI) defines depreciation as “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, effluxion of time or
obsolescence through technology and market-change. Depreciation is allocated
so as to charge fair proportion of depreciable amount in each accounting period
during the expected useful life of the asset. Depreciation includes amortisation
of assets whose useful life is pre-determined”.
© NCERT
not to be republished
229 Depreciation, Provisions and Reserves
Box  1
AS-6 (Revised): Depreciation
• Depreciation is “a measure of the wearing out, consumption or other loss of
value of depreciable asset arising from use, effluxion of time or obsolescence
through technology and market-change. Depreciation is allocated so as to charge
fair proportion of depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortisation of assets
whose useful life is pre-determined”.
• Depreciation has a significant effect in determining and presenting the financial
position and results of operations of an enterprise. Depreciation is charged in
each accounting period by reference to the extent of the depreciable amount.
• The subject matter of depreciation, or its base, are ‘depreciable’ assets which.
• “are expected to be used during more than one accounting period.
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and services,
for rental to others, or for administrative purposes and not for the purpose of
sale in the ordinary course of business.”
• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful
life and Net realisable value.
• Cost of a fixed asset is “the total cost spent in connection with its acquisition,
installation and commissioning as well as for add item or improvement of the
depreciable asset”.
• Useful life of an asset is the “period over which it is expected to be used by the
enterprise”.
• There are two main methods of calculating depreciation amount.
• straight line method
• written down value method
• Selection of appropriate method depends upon the following factors:
• type of the asset
• nature of the use of such asset
• circumstances prevailing in the business.
• The selected depreciation method should be applied consistently from period to
period. Change in depreciation method may be allowed only under specific
circumstances.
Depreciation has a significant effect in determining and presenting the
financial position and results of operations of an enterprise. Depreciation is
charged in each accounting period by reference to the extent of the depreciable
amount. It should be noted that the subject matter of depreciation, or its
base, are ‘depreciable’ assets which:
• “are expected to be used during more than one accounting period;
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative purposes and not for
the purpose of sale in the ordinary course of business.”
© NCERT
not to be republished
Page 4


M
atching principle requires that the revenue of
a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
entire cost as expense in the year in which it is
incurred. In fact, such a cost must be spread over
the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main
subject matter of the present chapter, deals with such
a situation. Further, it may not always be possible
to ascertain with certainty the amount of some
particular expense. Recall the principle of
conservatism (prudence) which requires that instead
of ignoring such items of costs, adequate provision
must be made and charged against profits of the
current period. Moreover, a part of profit may be
retained in the business in the form of reserves to
provide for growth, expansion or meeting certain
specific needs of the business in future. This  chapter
deals with two distinct topics and hence is being
presented in two different sections. First section deals
with depreciation and second section  deals with
provisions and reserves.
SECTION – I
7.1 Depreciation
Now you are aware that fixed assets are the assets
which are used in business for more than one
LEARNING OBJECTIVES
After studying this chapter,
you will be able to :
• explain the meaning of
depreciation and
distinguish it from
amortisation and
depletion;
• state the need for
charging depreciation
and identify its causes;
• compute depreciation
using straight line and
written down value
methods;
• record transactions
relating to depreciation
and disposition of
assets;
• explain the meaning
and purpose of creating
provisions and reserves;
• distinguish between
reserves and provisions;
• explain the nature of
various types of
provisions and reserves
including secret reserve.
Depreciation, Provisions and Reserves 7
© NCERT
not to be republished
228 Accountancy
accounting year. Fixed assets (technically referred to as “depreciable assets”)
tend to reduce their value once they are put to use. In general, the term
“Depreciation” means decline in the value of a fixed assets due to use, passage
of time or obsolescence. In other words, if a business enterprise procures a
machine and uses it in production process then the value of machine declines
with its usage. Even if the machine is not used in production process, we can
not expect it to realise the same sales price due to the passage of time or
arrival of a new model (obsolescence). It implies that fixed assets are subject
to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset
which has expired on account of its usage and/or lapse of time. Hence,
depreciation is an expired cost or expense, charged against the revenue of a
given accounting period. For example, a machine is purchased for Rs.1,00,000
on April 01, 2010. The useful life of the machine is estimated to be 10 years. It
implies that the machine can be used in the production process for next 10
years till March 31, 2015. You know that by its very nature, Rs. 1,00,000 is a
capital expenditure during the year 2010. However, when income statement
(Profit and Loss Account) is prepared, the entire amount of Rs.1,00,000 can not
be charged against the revenue for the year 2010, because of the reason that the
capital expenditure amounting to Rs.1,00,000 is expected to derive  benefits (or
revenue) for 10 years and not one year. Therefore, it is logical to charge only a
part of the total cost say Rs.10,000  (one tenth of   Rs. 1,00,000) against the
revenue for the year 2010. This part represents the expired cost or loss in the
value of machine on account of its use or passage of time and is referred to as
‘Depreciation’. The amount of depreciation, being a charge against profit, is
debited to the Profit  and Loss  Account.
7.1.1 Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual
shrinkage in the book value of fixed assets. It is based on the cost of assets
consumed in a business and not on its market value.
According to Institute of Cost and Management Accounting, London (ICMA)
terminology “ The depreciation is the diminution in intrinsic value of the asset
due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants
of India (ICAI) defines depreciation as “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, effluxion of time or
obsolescence through technology and market-change. Depreciation is allocated
so as to charge fair proportion of depreciable amount in each accounting period
during the expected useful life of the asset. Depreciation includes amortisation
of assets whose useful life is pre-determined”.
© NCERT
not to be republished
229 Depreciation, Provisions and Reserves
Box  1
AS-6 (Revised): Depreciation
• Depreciation is “a measure of the wearing out, consumption or other loss of
value of depreciable asset arising from use, effluxion of time or obsolescence
through technology and market-change. Depreciation is allocated so as to charge
fair proportion of depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortisation of assets
whose useful life is pre-determined”.
• Depreciation has a significant effect in determining and presenting the financial
position and results of operations of an enterprise. Depreciation is charged in
each accounting period by reference to the extent of the depreciable amount.
• The subject matter of depreciation, or its base, are ‘depreciable’ assets which.
• “are expected to be used during more than one accounting period.
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and services,
for rental to others, or for administrative purposes and not for the purpose of
sale in the ordinary course of business.”
• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful
life and Net realisable value.
• Cost of a fixed asset is “the total cost spent in connection with its acquisition,
installation and commissioning as well as for add item or improvement of the
depreciable asset”.
• Useful life of an asset is the “period over which it is expected to be used by the
enterprise”.
• There are two main methods of calculating depreciation amount.
• straight line method
• written down value method
• Selection of appropriate method depends upon the following factors:
• type of the asset
• nature of the use of such asset
• circumstances prevailing in the business.
• The selected depreciation method should be applied consistently from period to
period. Change in depreciation method may be allowed only under specific
circumstances.
Depreciation has a significant effect in determining and presenting the
financial position and results of operations of an enterprise. Depreciation is
charged in each accounting period by reference to the extent of the depreciable
amount. It should be noted that the subject matter of depreciation, or its
base, are ‘depreciable’ assets which:
• “are expected to be used during more than one accounting period;
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative purposes and not for
the purpose of sale in the ordinary course of business.”
© NCERT
not to be republished
230 Accountancy
Examples of depreciable assets are machines, plants, furnitures, buildings,
computers, trucks, vans, equipments, etc. Moreover, depreciation is the
allocation of ‘depreciable amount’, which is the “historical cost”, or other
amount substituted for historical cost less estimated salvage value.
Another point in the allocation of depreciable amount is the ‘expected useful
life’ of an asset. It has been described as “either (i) the period over which a
depreciable asset is expected to the used by the enterprise, or (ii) the number
of production of similar units expected to be obtained from the use of the
asset by the enterprise.”
7.1.2 Features of Depreciation
Above mentioned discussion on depreciation highlights the following features
of depreciation:
1. It is decline in the book value of fixed assets.
2. It includes loss of value due to effluxion of time, usage or obsolescence.
For example, a business firm buys a machine for Rs. 1,00,000 on  April
01, 2000. In the year 2002, a new version of the machine arrives in the
market. As a result, the machine bought by the business firm becomes
outdated. The resultant decline in the value of old machine is caused by
obsolescence.
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable
profits. For example, if profit before depreciation and tax is Rs. 50,000,
and depreciation is Rs. 10,000; profit before tax will be:
  (Rs.)
Profit before depreciation & tax 50,000
 (-) Depreciation (10,000)
Profit before tax 40,000
5. It is a non-cash expense. It does not involve any cash outflow. It is the
process of writing-off the capital expenditure already incurred.
Do it Yourself
 Look at your surroundings and identify at least five depreciable assets in your home,
school, hospital, printing press and in a bakery.
© NCERT
not to be republished
Page 5


M
atching principle requires that the revenue of
a given period is matched against the expenses
for the same period. This ensures ascertainment of
the correct amount of profit or loss. If some cost is
incurred whose benefit extend to more than one
accounting period, it is not justified to charge the
entire cost as expense in the year in which it is
incurred. In fact, such a cost must be spread over
the periods in which it provides benefits.
Depreciation, on fixed assets, which is the main
subject matter of the present chapter, deals with such
a situation. Further, it may not always be possible
to ascertain with certainty the amount of some
particular expense. Recall the principle of
conservatism (prudence) which requires that instead
of ignoring such items of costs, adequate provision
must be made and charged against profits of the
current period. Moreover, a part of profit may be
retained in the business in the form of reserves to
provide for growth, expansion or meeting certain
specific needs of the business in future. This  chapter
deals with two distinct topics and hence is being
presented in two different sections. First section deals
with depreciation and second section  deals with
provisions and reserves.
SECTION – I
7.1 Depreciation
Now you are aware that fixed assets are the assets
which are used in business for more than one
LEARNING OBJECTIVES
After studying this chapter,
you will be able to :
• explain the meaning of
depreciation and
distinguish it from
amortisation and
depletion;
• state the need for
charging depreciation
and identify its causes;
• compute depreciation
using straight line and
written down value
methods;
• record transactions
relating to depreciation
and disposition of
assets;
• explain the meaning
and purpose of creating
provisions and reserves;
• distinguish between
reserves and provisions;
• explain the nature of
various types of
provisions and reserves
including secret reserve.
Depreciation, Provisions and Reserves 7
© NCERT
not to be republished
228 Accountancy
accounting year. Fixed assets (technically referred to as “depreciable assets”)
tend to reduce their value once they are put to use. In general, the term
“Depreciation” means decline in the value of a fixed assets due to use, passage
of time or obsolescence. In other words, if a business enterprise procures a
machine and uses it in production process then the value of machine declines
with its usage. Even if the machine is not used in production process, we can
not expect it to realise the same sales price due to the passage of time or
arrival of a new model (obsolescence). It implies that fixed assets are subject
to decline in value and this decline is technically referred to as depreciation.
As an accounting term, depreciation is that part of the cost of a fixed asset
which has expired on account of its usage and/or lapse of time. Hence,
depreciation is an expired cost or expense, charged against the revenue of a
given accounting period. For example, a machine is purchased for Rs.1,00,000
on April 01, 2010. The useful life of the machine is estimated to be 10 years. It
implies that the machine can be used in the production process for next 10
years till March 31, 2015. You know that by its very nature, Rs. 1,00,000 is a
capital expenditure during the year 2010. However, when income statement
(Profit and Loss Account) is prepared, the entire amount of Rs.1,00,000 can not
be charged against the revenue for the year 2010, because of the reason that the
capital expenditure amounting to Rs.1,00,000 is expected to derive  benefits (or
revenue) for 10 years and not one year. Therefore, it is logical to charge only a
part of the total cost say Rs.10,000  (one tenth of   Rs. 1,00,000) against the
revenue for the year 2010. This part represents the expired cost or loss in the
value of machine on account of its use or passage of time and is referred to as
‘Depreciation’. The amount of depreciation, being a charge against profit, is
debited to the Profit  and Loss  Account.
7.1.1 Meaning of Depreciation
Depreciation may be described as a permanent, continuing and gradual
shrinkage in the book value of fixed assets. It is based on the cost of assets
consumed in a business and not on its market value.
According to Institute of Cost and Management Accounting, London (ICMA)
terminology “ The depreciation is the diminution in intrinsic value of the asset
due to use and/or lapse of time.”
Accounting Standard-6 issued by The Institute of Chartered Accountants
of India (ICAI) defines depreciation as “a measure of the wearing out, consumption
or other loss of value of depreciable asset arising from use, effluxion of time or
obsolescence through technology and market-change. Depreciation is allocated
so as to charge fair proportion of depreciable amount in each accounting period
during the expected useful life of the asset. Depreciation includes amortisation
of assets whose useful life is pre-determined”.
© NCERT
not to be republished
229 Depreciation, Provisions and Reserves
Box  1
AS-6 (Revised): Depreciation
• Depreciation is “a measure of the wearing out, consumption or other loss of
value of depreciable asset arising from use, effluxion of time or obsolescence
through technology and market-change. Depreciation is allocated so as to charge
fair proportion of depreciable amount in each accounting period during the
expected useful life of the asset. Depreciation includes amortisation of assets
whose useful life is pre-determined”.
• Depreciation has a significant effect in determining and presenting the financial
position and results of operations of an enterprise. Depreciation is charged in
each accounting period by reference to the extent of the depreciable amount.
• The subject matter of depreciation, or its base, are ‘depreciable’ assets which.
• “are expected to be used during more than one accounting period.
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and services,
for rental to others, or for administrative purposes and not for the purpose of
sale in the ordinary course of business.”
• The amount of depreciation basically depends upon three factors, i.e. Cost, Useful
life and Net realisable value.
• Cost of a fixed asset is “the total cost spent in connection with its acquisition,
installation and commissioning as well as for add item or improvement of the
depreciable asset”.
• Useful life of an asset is the “period over which it is expected to be used by the
enterprise”.
• There are two main methods of calculating depreciation amount.
• straight line method
• written down value method
• Selection of appropriate method depends upon the following factors:
• type of the asset
• nature of the use of such asset
• circumstances prevailing in the business.
• The selected depreciation method should be applied consistently from period to
period. Change in depreciation method may be allowed only under specific
circumstances.
Depreciation has a significant effect in determining and presenting the
financial position and results of operations of an enterprise. Depreciation is
charged in each accounting period by reference to the extent of the depreciable
amount. It should be noted that the subject matter of depreciation, or its
base, are ‘depreciable’ assets which:
• “are expected to be used during more than one accounting period;
• have a limited useful life; and
• are held by an enterprise for use in production or supply of goods and
services, for rental to others, or for administrative purposes and not for
the purpose of sale in the ordinary course of business.”
© NCERT
not to be republished
230 Accountancy
Examples of depreciable assets are machines, plants, furnitures, buildings,
computers, trucks, vans, equipments, etc. Moreover, depreciation is the
allocation of ‘depreciable amount’, which is the “historical cost”, or other
amount substituted for historical cost less estimated salvage value.
Another point in the allocation of depreciable amount is the ‘expected useful
life’ of an asset. It has been described as “either (i) the period over which a
depreciable asset is expected to the used by the enterprise, or (ii) the number
of production of similar units expected to be obtained from the use of the
asset by the enterprise.”
7.1.2 Features of Depreciation
Above mentioned discussion on depreciation highlights the following features
of depreciation:
1. It is decline in the book value of fixed assets.
2. It includes loss of value due to effluxion of time, usage or obsolescence.
For example, a business firm buys a machine for Rs. 1,00,000 on  April
01, 2000. In the year 2002, a new version of the machine arrives in the
market. As a result, the machine bought by the business firm becomes
outdated. The resultant decline in the value of old machine is caused by
obsolescence.
3. It is a continuing process.
4. It is an expired cost and hence must be deducted before calculating taxable
profits. For example, if profit before depreciation and tax is Rs. 50,000,
and depreciation is Rs. 10,000; profit before tax will be:
  (Rs.)
Profit before depreciation & tax 50,000
 (-) Depreciation (10,000)
Profit before tax 40,000
5. It is a non-cash expense. It does not involve any cash outflow. It is the
process of writing-off the capital expenditure already incurred.
Do it Yourself
 Look at your surroundings and identify at least five depreciable assets in your home,
school, hospital, printing press and in a bakery.
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231 Depreciation, Provisions and Reserves
7.2 Depreciation and other Similar Terms
There are some terms like ‘depletion’ and ‘amortisation’, which are also used in
connection with depreciation. This has been due to the similar treatment given
to them in accounting on the basis of similarity of their outcome, as they represent
the expiry of the usefulness of different assets.
7.2.1 Depletion
The term depletion is used in the context of extraction of natural resources like
mines, quarries, etc. that reduces the availability of the quantity of the material
or asset. For example, if a business enterprise is into mining business and
purchases a coal mine for Rs. 10,00,000. Then the value of coal mine declines
with the extraction of coal out of the mine. This decline in the value of mine is
termed as depletion. The main difference between depletion and depreciation is
that the former is concerned with the exhaution of economic resources, but the
latter relates to the usage of an asset. In spite of this, the result is erosion in the
volume of natural resources and expiry of the service potential. Therefore,
depletion and depreciation are given similar accounting treatment.
7.2.2 Amortisation
Amortisation refers to writing-off the cost of intangible assets like patents,
copyright, trade marks, franchises, goodwill which have utility for a specified
period of time. The procedure for amortisation or periodic write-off of a portion
of the cost of intangible assets is the same as that for the depreciation of fixed
assets. For example, if a business firm buys a patent for Rs. 10,00,000 and
estimates that its useful life will be 10 years then the business firm must write-
off  Rs. 10,00,000 over 10 years. The amount so written- off is technically referred
to as amortisation.
7.3 Causes of Depreciation
These have been very clearly spelt out as part of the definition of depreciation in
the Accounting Standard 6 and are being elaborated here.
7.3.1 Wear and Tear due to Use or Passage of Time
Wear and tear means deterioration, and the consequent diminution in an assets
value, arising from its use in business operations for earning  revenue. It reduces
the asset’s technical capacities to serve the purpose for, which it has been meant.
Another aspect of wear and tear is the physical deterioration. An asset
deteriorates simply with the passage of time, even though they are not being put
to any use. This happens especially when the assets are exposed to the rigours
of nature like weather, winds, rains, etc.
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