CBSE Class 11 Accountancy Chapter 7: Depreciation, Provision and Reserve NCERT Solutions

Solution: Depreciation refers to the gradual decrease in the book value of a fixed asset over its useful life. Businesses acquire assets like machinery, buildings, or vehicles for use over an extended period. Due to regular usage, exposure to the elements, or simply the passage of time, these assets experience wear and tear, leading to a reduction in their value. This loss in value is systematically recognized in the accounting records as depreciation. For instance, if a business purchases machinery for Rs 1,00,000 with an estimated useful life of 10 years, the annual depreciation can be calculated using the formula:

$$\backslash text\{Annual\; Depreciation\; (p.a.)\}\; =\; \backslash frac\{\backslash text\{Cost\; of\; Assets\}\}\{\backslash text\{Expected\; or\; Estimated\; Life\; of\; Assets\}\}$$

Applying this to the example:

$\backslash text\{Annual\; Depreciation\; (p.a)\}\; =\; \backslash frac\{100000\}\{10\}\; =\; \backslash text\{Rs\; \}\; 10000$

This means Rs 10,000 is recognized as an expense each year for 10 years.

Solution: Providing for depreciation is essential in accounting for several key reasons:

1. To ascertain true net profit or net loss: Correctly calculating profit or loss requires charging all expenses incurred in earning revenue. Depreciation, as a cost of using an asset, must be charged to the Profit and Loss Account to reflect the true profitability.
2. To show a true and fair view of financial statements: If depreciation is not recorded, assets will be shown at a value higher than their actual worth on the Balance Sheet. This misrepresentation prevents the financial statements from providing a true and fair view of the company's financial position.
3. For ascertaining the accurate cost of production: Depreciation on assets used in production, such as plant and machinery, is a component of the cost of production. Omitting this cost leads to an underestimation of the production cost, potentially resulting in an incorrect pricing strategy and reduced profits.
4. Distribution of dividend out of profit: Failing to charge depreciation can lead to an overstatement of profits. Distributing dividends based on these inflated profits might mean distributing capital instead of actual profits, which is detrimental to the business.
5. To provide funds for replacement of assets: While depreciation itself is not a cash expense, the amount charged to profit and loss is retained within the business. This accumulated amount can be used to replace the fixed assets once they reach the end of their useful life.
6. Consideration of tax: Charging depreciation reduces the taxable profit. A lower profit figure results in a lower tax liability for the business, offering a tax advantage.

Solution: Depreciation arises from various factors that lead to a decrease in the value of an asset over time. The primary causes can be categorized as follows:

1. Physical factors: This includes the wear and tear that an asset undergoes due to regular use. For example, machinery parts may become worn out, or a vehicle's engine may degrade with mileage.
2. Abiotic factors: The simple passage of time can cause an asset's value to decline, even if it is not actively used. For instance, certain equipment might become outdated or less effective simply because time has passed.
3. Technological advancements (Obsolescence): New technologies or improved models of existing assets can make older ones outdated or less efficient. This technological obsolescence leads to a fall in the value of the older asset, even if it is still in good working condition.
4. Legal factors: Some assets have a limited legal life, such as patents or copyrights. Their value diminishes as the period of their legal protection expires.
5. Accidents: Unexpected events like accidents can also cause damage to an asset, leading to a reduction in its value.

These factors collectively contribute to the decrease in an asset's utility and, consequently, its value over its useful life.