Depreciation, Provisions and Reserves

Depreciation by the straight line and written down value methods, part years, sale of an asset, the provision for depreciation, and provisions against reserves.

Key ideas

• Depreciation is the fall in a fixed asset’s value from use, time or obsolescence; depletion is for mines and oil wells, amortisation for patents, copyrights and trademarks.
• The cost to be depreciated includes the price and every cost of getting the asset ready, such as carriage and installation.
• Straight line method: the same charge every year on the original cost, so the book value can fall to scrap value or zero.
• Written down value method: a fixed rate on each year’s opening book value, so the charge falls every year and the book value never reaches zero.
• For an asset bought during the year, the first year’s charge is only for the months it was used.
• Depreciation is either credited to the asset account, or to a provision for depreciation account so the asset stays at cost.
• A provision is a charge against profit for a known loss or liability (doubtful debts, depreciation, tax); a reserve is profit set aside (general, capital or secret reserve).

Remember

Watch out

• Applying the written down value rate to the original cost every year.
• Charging a full year’s depreciation on an asset bought during the year.
• Leaving installation and carriage out of the cost.
• Calling a provision for doubtful debts a reserve.

Worked example