Depreciation, Provisions and Reserves

As an accounting term, depreciation is that part of the cost of a fixed asset which has expired on account of its usage and/or lapse of time. Hence, depreciation is an expired cost or expense, charged against the revenue of a given accounting period. For example, a machine is purchased for Rs. , , on April , .

The useful life of the machine is estimated to be years. It implies that the machine can be used in the production process for next years till March , . You know that by its very nature, Rs. , , is a capital expenditure during the year - .

However, when income statement (Statement of Profit and Loss) is prepared, the entire amount of Rs. , , can not be charged against the revenue for the year - , because of the reason that the capital expenditure amounting to Rs. , , is expected to derive benefits (or revenue) for years and not one year. Therefore, it is logical to charge only a part of the total cost say Rs.

, (one tenth of Rs. , , ) against the revenue for the year - . This part represents the expired cost or loss in the value of machine on account of its use or passage of time and is referred to as ‘Depreciation’. The amount of depreciation, being a charge against profit, is debited to Income Statement (Statement of Profit and Loss).