Depreciation Provisions and Reserves Test - 69

Under the straight-line method of depreciation, the depreciation expense is calculated based on the cost of the asset less its estimated salvage value (scrap value). The formula for straight-line depreciation is:

Depreciation Expense \(= \frac{(\text{Cost of Asset - Salvage Value}) }{\text{ Useful Life}}\)

Salvage value or scrap value represents the estimated value of the asset at the end of its useful life. This value is subtracted from the initial cost of the asset to determine the depreciable base over which the depreciation is calculated. Therefore, the depreciation is based on the cost of the asset less any expected residual value.

Specific reserves are created to meet specific purposes and contingencies. They can be utilised only for that purpose. Example: Dividend equalisation reserve, Capital redemption reserve.

Provisions are amounts set aside for specific liabilities, whereas reserves are amounts set aside for general purposes. Provisions are made for anticipated future expenses or losses, such as bad debts, warranties, or legal claims, whereas reserves are set aside for general or unspecified purposes, such as future expansions or contingencies. Provisions are recognized as liabilities on the balance sheet, whereas reserves are reported as part of shareholders' equity.

Depreciation is the decline in the value of a fixed asset over time due to factors such as wear and tear, obsolescence, and aging.

Revenue reserve is the reserve created out of the profits earned in the normal course of the business. These profits are available for distribution as dividend.

Depreciation under the Straight Line Method is recognized as a non-cash expense, meaning it represents the allocation of the asset's cost over its useful life but does not involve an actual cash outflow.

One of the limitations of the WDV method is that a significant portion of the asset's cost is written off in the earlier years, which may not fully reflect the loss in value due to obsolescence over time.

Depreciation expense under the Straight Line Method is calculated by dividing the depreciable cost of the asset (cost minus salvage value) by its useful life.

Total cost of an asset = Purchase price + Freight + Installation cost. Refundable tax does not form part of the cost of an asset.

The useful life of the asset and the residual value of the asset can only be an estimate because the asset may become obselete before the estimated useful life and it may not fetch the estimated residual value. But the Cost of the asset is actual cost incurred in acquistion of the asset.