CBSE Class 11 Accountancy: Depreciation, Provisions and Reserves NCERT Solutions

Depreciation refers to the decrease in the book value of a depreciable fixed asset. This reduction in value occurs due to several factors, including:

1. Wear and tear: Normal usage of an asset leads to physical deterioration and reduced efficiency over time.
2. Passage of time: Even if an asset is not used, its value may decrease simply due to the aging process or the expiry of its economic life.
3. Obsolescence: Technological advancements, new inventions, or changes in market demand can make an existing asset outdated and less valuable.
4. Accident: Unexpected events like fire, floods, or other mishaps can cause permanent damage to an asset, reducing its value.

For example, if a machinery costing ₹ 1,00,000 has an estimated useful life of 10 years and no scrap value, the annual depreciation would be calculated as:

$$Annual\; Depreciation\; =\; \backslash frac\{\backslash text\{Cost\; of\; Asset\}\; -\; \backslash text\{Estimated\; Scrap\; Value\}\}\{\backslash text\{Expected\; or\; Estimated\; Life\; of\; Asset\}\}$$

$$Annual\; Depreciation\; =\; \backslash frac\{₹\; 1,00,000\; -\; ₹\; 0\}\{10\; \backslash text\{\; years\}\}\; =\; ₹\; 10,000\; \backslash text\{\; per\; annum\}$$

Providing depreciation is essential for several reasons in accounting:

1. To ascertain the correct profit or loss: Charging depreciation as an expense ensures that all costs incurred in earning revenue are accounted for. This leads to an accurate calculation of profit or loss for a given period.
2. To show a true and fair view of financial statements: If depreciation is not charged, assets will be overstated on the Balance Sheet. This would present a misleading financial position, failing to provide a true and fair view to stakeholders.
3. For ascertaining the accurate cost of production: Depreciation on assets used in production is a part of the cost of goods produced. Omitting it would underestimate the production cost, potentially leading to incorrect pricing and reduced profits.
4. To provide funds for replacement of assets: Depreciation is a non-cash expense. The amount debited to the Profit and Loss Account is retained within the business. Over time, these accumulated funds can be used to replace the asset when it reaches the end of its useful life.
5. To meet legal requirements: Various statutes, such as the Companies Act and Income Tax Act, mandate the charging of depreciation for compliance and tax purposes.

The primary causes that lead to a decrease in the value of a fixed asset, known as depreciation, are:

1. Use of asset (Wear and Tear): Continuous usage of an asset results in physical wear and tear, reducing its efficiency and value over time. For example, a machine used daily will gradually lose its effectiveness.
2. Passage of Time: Even if an asset is not actively used, its value can diminish simply due to the mere passage of time. This is particularly relevant for assets with a limited economic lifespan or those subject to deterioration.
3. Obsolescence: The introduction of new technologies, improved designs, or innovative processes can render existing assets outdated. This technological obsolescence leads to a fall in the value of older assets, even if they are still functional.
4. Accident: Assets can suffer damage due to unforeseen events like fire, floods, earthquakes, or accidents. Such damage can be permanent and significantly reduce the asset's value or render it unusable.

The amount of depreciation charged each year is influenced by several key factors:

1. Original Cost of Asset: This is the total expenditure incurred to acquire the asset and bring it to its working condition and location. It includes the purchase price, plus any expenses like freight, transportation, installation charges, and initial testing costs. The depreciation calculation starts with this total cost. The formula for total cost is: $$Total\; Cost\; =\; Purchase\; Price\; +\; Freight\; Expenses\; +\; Installation\; Charges$$
2. Estimated Useful Life: This refers to the period (in years or units of production) during which the business expects to use the asset. It's not necessarily the physical life of the asset but its economic life – the period over which it can be used profitably. For accounting purposes, the shorter of the physical or economic life is considered. For instance, if an asset physically lasts 20 years but is expected to be economically useful for only 15 years, the useful life for depreciation is taken as 15 years.
3. Estimated Scrap Value: This is the net amount expected to be realized from the sale or disposal of an asset at the end of its useful life. This estimated value is deducted from the original cost of the asset. The remaining amount (Cost minus Scrap Value) is then written off over the asset's useful life. For example, if furniture costing ₹ 1,30,000 has an estimated useful life of 10 years and a scrap value of ₹ 10,000, the annual depreciation would be calculated as: $$Depreciation\; per\; annum\; =\; \backslash frac\{₹\; 1,30,000\; -\; ₹\; 10,000\}\{10\; \backslash text\{\; years\}\}\; =\; \backslash frac\{₹\; 1,20,000\}\{10\}\; =\; ₹\; 12,000$$

The Straight Line Method (SLM) and the Written Down Value (WDV) Method are two primary ways to calculate depreciation. Here's a distinction between them:

Straight Line Method (SLM):

• Depreciation Amount: A fixed amount of depreciation is charged every year throughout the useful life of the asset.
• Calculation Basis: Depreciation is calculated on the original cost of the asset. The formula is: $$Annual\; Depreciation\; =\; \backslash frac\{\backslash text\{Original\; Cost\}\; -\; \backslash text\{Scrap\; Value\}\}\{\backslash text\{Useful\; Life\; in\; Years\}\}$$
• Impact on Profit: The charge to the Profit and Loss Account is constant each year.
• Book Value: The book value of the asset reduces to its scrap value at the end of its useful life.
• Suitability: Suitable for assets whose efficiency does not decline significantly with age and where usage is relatively constant.

Written Down Value (WDV) Method:

• Depreciation Amount: A fixed rate of depreciation is applied to the book value of the asset at the beginning of each accounting period. This results in a decreasing amount of depreciation charged each year.
• Calculation Basis: Depreciation is calculated on the diminishing book value (original cost minus accumulated depreciation) of the asset. The formula is: $$Depreciation\; =\; Book\; Value\; at\; the\; beginning\; of\; the\; year\; \backslash times\; Rate\; of\; Depreciation$$
• Impact on Profit: The charge to the Profit and Loss Account decreases each year.
• Book Value: The book value of the asset gradually reduces and theoretically never reaches zero (unless the rate is 100% or scrap value is zero and the asset is fully depreciated).
• Suitability: Suitable for assets whose efficiency declines with age and usage, or where repairs and maintenance costs increase over time (e.g., machinery, vehicles).