Depreciation, Reserves, and Provisions

Depreciation:

Every business acquires mounted assets for its use within the business over an amount of your time.

As the advantages of those assets are often availed over a protracted amount of your time, thus, thanks to their regular use, there happens continuous wear and tear and consequently fall in their value. This fall within the worth of mounted assets, due to their regular use or expiry of time is termed as depreciation.

Use of depreciation :

  • To ascertain true net income or internet loss− Correct profit or loss are often determined once all the expenses and losses incurred for earning revenues square measure charged to Profit and Loss Account. Assets square measure used for earning revenues and its price is charged in a variety of depreciation from Profit and Loss Account.
  • To show true and honest read of monetary statements− If depreciation isn’t charged, assets are shown at a higher value than their actual value in the Balance Sheet; consequently, the Balance Sheet does not reflect the true and fair view of financial statements.
  • For ascertaining the correct price of production− Depreciation on plant and machinery and alternative assets, which are engaged in production, is included in the cost of production. If depreciation isn’t enclosed, the cost of production is underestimated, which will lead to a low sale price and thus leads to low profit.
  • Distribution of dividend out of profit− If depreciation isn’t charged, which leads to overestimating of profit and consequently more profit is distributed as a dividend, out of capital instead of the profit. This ends up in the flight of scarce capital out of the business.

Reserves:

Reserves square measure created for strengthening the money positions and future growth.

It is created out of profit attained by the business.

classification of reserve :

  1. Revenue Reserve− it’s created out of revenue profit, i.e., revenue earned from normal activities of the business. It is often used for either general purpose or specific purpose.
  2. Capital Reserve− it’s created out of capital profit, i.e., gain from aside from traditional activities of business operations, such as the sale of fixed assets, etc. It is created to meet the capital loss. It cannot be distributed as a dividend.
  3. Secret Reserves− Reserves that square measure created by overstating liabilities or understating assets square measure referred to as secret reserves.

Provisions:

Provision is to be created in respect of a liability, that is definite to be incurred, however, its correct quantity isn’t legendary. It’s charged within the Profit and loss Account on an estimate basis.

It ought to be clearly understood that if the number of a legendary liability is often determined with affordable accuracy, it can’t a provision.

Examples of Provision are Provision for Depreciation on assets, Provision for Repairs and Renewals of assets, Provision for Taxation, Provision for Discount on Debtors, Provision for dangerous and uncertain Debts.

Notes: Provision could be a charge against profits it suggests that provision has got to be created regardless of commerce it earning enough profits or acquisition losses.

 

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