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  1. Meaning of depreciation: Depreciation is decline in the value of a tangible fixed asset. In accounting, depreciation is the process of allocating depreciable cost over useful life of a fixed asset.
  2. Depreciation and similar terms: Depreciation term is used in the context of tangible fixed assts. Depletion (in the case of extractive industries), and amortisation (in the case of intangible assets) are other related terms.
Factors Affecting Depreciation:
  • Wear and Tear due to use and/or passage of time
  • Expiration of Legal Rights
  • Obsolescence
  1. Importance of depreciation:
    • Depreciation must be charged to ascertain true and fair profit or loss.
    • Depreciation is a non-cash operating expense.
  2. Methods of charging depreciation: Depreciation amount can be calculated using:
    • ​Straight line method, or
    • Written down value method
  3. Factors affecting the amount of depreciation:
    Depreciation amount is determined by —
    • Original cost
    • Salvage value, and
    • Useful life of the asset
  4. Provisions and Reserves: A provision is a charge against profit. It is created for a known current liability the amount of which is uncertain. Reserve on the other hand, is an appropriation of profit. It is created to strengthen the financial position of the business.
  5. Types of Reserves:
    Reserves may be —
    • General reserve and specific reserve;
    • Revenue reserve and capital reserve.
  6. Secret Reserve: When total depreciation charged is higher than the total depreciable cost, Secret reserve' is created. Secret reserve is not explicitly shown in the balance sheet.

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