Depreciation Provisions and Reserves Test - 32

Depreciation is a decrease in the value of the fixed assets due to wear and tear, obsolescence and passage of time.

solution:

Under Written down method of depreciation annual depreciation charges bears a fixed % of book value of the assets.

Option C is correct. In accounting, Consistency principle requires that a company's financial statements should follow same accounting principles, methods, procedures and practices from one accounting period to another. This allows the readers of the financial statements to make meaningful comparison. So, if a company follows same method of depreciation year after year, it is due to consistency principle. 

Definition

A provision can be a liability of uncertain timing or amount. A liability, in turn, is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.

Though it is often thought to be, a provision should not be considered to be a form of savings. Examples are; income tax liability, product warranty, environment restoration,etc.

Recognition

A provision shall be recognized if the following criteria are fulfilled:

1.      an entity has a present obligation as a result of a past event;

2.      it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation;

3.      a reliable estimate can be made of the amount of the obligation.

4.      a specific current statement, the entity will accept certain responsibilities and other parties have valid expectations that the entity will discharge its responsibilities.

No provision, however, is recognized for costs that need to be incurred to operate in the future. Also, an obligation always involves another party to whom the obligation is owed (even if this party is unknown). 

Companies use their cash flow to make payments for fixed assets. Depreciation spreads the expense of a fixed asset over the years of the estimated useful life of the asset. The accounting entries for depreciation are a debit to depreciation expense and a credit to fixed asset depreciation accumulation.