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Depreciation, Provisions and Reserves – Class 11 Accountancy notes, important questions and MCQs

NCERT Class 11 Accountancy, chapter 7. Notes, key terms, important questions with answers and MCQs.

Chapter overview

Depreciation is the gradual decrease in the value of fixed assets due to use, passage of time or obsolescence. It is charged to the profit and loss account so that profit is correctly measured and assets are shown at a fair value. Provisions are charges against profit for known liabilities or losses whose amount is uncertain, while reserves are appropriations of profit kept to strengthen the business.

Depreciation

Causes: wear and tear from use, expiry of legal rights (such as patents or leases), obsolescence due to new technology, and passage of time; abnormal factors such as accidents also reduce value.
Need: to match the cost of the asset with revenue, to show assets at fair value, to calculate true profit and to retain funds for replacement.
Factors: cost of the asset, estimated useful life and estimated scrap (residual) value.

Methods of depreciation

Straight line method (SLM): equal depreciation every year; annual depreciation = (cost − scrap value) ÷ useful life.
Written down value method (WDV): a fixed percentage is charged on the reducing book value each year, so depreciation falls over time.
Depreciation may be credited to the asset account directly or accumulated in a provision for depreciation account.

Provisions and reserves

A provision is a charge against profit for a known liability or loss of uncertain amount, such as provision for doubtful debts or for taxation.
A reserve is an appropriation of profit to strengthen the financial position; examples are general reserve and specific reserves such as dividend equalisation reserve.
A capital reserve is created out of capital profits, such as profit on sale of fixed assets; a secret reserve is not disclosed in the balance sheet.

Key terms

Depreciation: the gradual decline in the value of a fixed asset due to use, time or obsolescence
Straight line method: charging an equal amount of depreciation every year
Written down value method: charging a fixed percentage of depreciation on the reducing book value each year
Provision: a charge against profit for a known liability or loss of uncertain amount
Reserve: an appropriation of profit retained to strengthen the business

Important questions with answers

State the causes of depreciation.2 marks

Depreciation is caused by wear and tear due to use of the asset, expiry of legal rights such as patents and leases, obsolescence due to new technology or changes in demand, passage of time, and abnormal factors such as accidents.

Distinguish between provision and reserve.3 marks

A provision is a charge against profit made for a known liability or loss whose amount is uncertain, such as provision for doubtful debts; it must be made whether there is profit or not and reduces net profit. A reserve is an appropriation of profit to strengthen the business, such as general reserve; it is created only when there is profit and does not reduce net profit.

Compare the straight line method and the written down value method of depreciation. Calculate depreciation for two years on a machine costing ₹1,00,000 (scrap value nil, life 10 years for SLM; rate 10 per cent for WDV).5 marks

Under the straight line method, depreciation is charged at a fixed amount every year, calculated as (cost − scrap value) ÷ useful life, so the book value of the asset falls by equal amounts and can become zero. It is simple and suitable for assets such as leases and patents, where use is even over time, but it ignores the fact that repair costs rise as assets age. Under the written down value method, a fixed percentage is charged on the reducing book value each year, so depreciation is higher in early years and lower later, and the book value never becomes zero. It balances the total charge of depreciation and repairs over the asset's life and is accepted by income tax law, but the rate is harder to determine. For the machine of ₹1,00,000: by SLM, annual depreciation = ₹1,00,000 ÷ 10 = ₹10,000 in each of the two years, leaving a book value of ₹80,000 at the end of year two. By WDV at 10 per cent, year one depreciation = ₹10,000 (book value ₹90,000), and year two depreciation = 10 per cent of ₹90,000 = ₹9,000, leaving a book value of ₹81,000.

Quick revision

Causes: wear and tear, expiry, obsolescence, time.
SLM = (cost − scrap) ÷ life; equal every year.
WDV = fixed percentage on reducing balance.
Provision = charge; reserve = appropriation.

Exam tips

Remember: provisions are charged against profit (before profit); reserves are appropriations of profit (after profit).
Practise one SLM and one WDV table for three years.

Practice MCQs

The gradual fall in the value of fixed assets is called
1. appreciation
2. amortisation of capital
3. depreciation
4. inflation
Show answer
Answer: (c) depreciation. It is a non-cash expense.
Under the straight line method, annual depreciation is
1. increasing
2. decreasing
3. equal every year
4. zero
Show answer
Answer: (c) equal every year. It is a fixed amount.
Provision for doubtful debts is an example of
1. a reserve
2. a provision
3. capital
4. revenue
Show answer
Answer: (b) a provision. The loss amount is uncertain.
A machine costs ₹1,00,000, scrap value ₹10,000, life 5 years. Annual depreciation by SLM is
1. ₹20,000
2. ₹22,000
3. ₹10,000
4. ₹18,000
Show answer
Answer: (d) ₹18,000. (1,00,000 − 10,000) ÷ 5.
Under the WDV method, depreciation in later years is
1. higher
2. equal
3. lower
4. zero
Show answer
Answer: (c) lower. It is charged on a reducing balance.
Profit on sale of fixed assets is usually transferred to
1. general reserve
2. sales account
3. provision for tax
4. capital reserve
Show answer
Answer: (d) capital reserve. It is a capital profit.
A machine costing ₹1,00,000 is depreciated at 10 per cent WDV. Depreciation in the second year is
1. ₹9,000
2. ₹10,000
3. ₹8,100
4. ₹19,000
Show answer
Answer: (a) ₹9,000. 10 per cent of ₹90,000.
Which statement is correct
1. reserves are charged against profit
2. provisions are created only from capital profits
3. provisions are charged against profit, reserves are appropriations of profit
4. reserves reduce net profit
Show answer
Answer: (c) provisions are charged against profit, reserves are appropriations of profit. This is the key difference.

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Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.