Welcome to Unit 3 of your Financial Accounting course, designed specifically for BBA 1st Semester students. This unit introduces two essential financial concepts: Depreciation and Provisions & Reserves.
You’ll learn how businesses account for the reduction in asset value over time, and how they create financial cushions to manage future uncertainties. These concepts are key to presenting accurate and realistic financial statements.
Download Unit 3 Notes – Depreciation, Provisions & Reserves (PDF)
Click below to get the Unit 3 Financial Accounting Notes in PDF format – perfect for BBA students looking to revise quickly and clearly:
Download Unit 3 – Depreciation, Provisions & Reserves Notes (PDF)
These notes are concise, well-organized, and ideal for both class preparation and exams.
What is Depreciation?
Depreciation refers to the gradual decrease in the value of a fixed asset due to usage, time, wear and tear, or obsolescence. It is a non-cash expense, yet an important part of accounting.
Definition, Causes, and Need for Depreciation
In this section, you’ll understand:
Definition of depreciation in accounting terms
Causes: Physical wear and tear, passage of time, obsolescence, usage, legal limits
Need: To show true asset value, match cost with revenue, plan for asset replacement, and ensure fair profit reporting
Recording depreciation ensures transparency and compliance in financial reporting.
Methods of Depreciation
You will study the two most commonly used methods:
1. Straight Line Method (SLM)
Equal amount of depreciation is charged every year
Formula:
Depreciation = (Cost – Scrap Value) / Useful Life
2. Written Down Value Method (WDV)
A fixed percentage of depreciation is applied to the book value every year
Depreciation amount reduces over time
The choice of method depends on the nature of the asset and company policy.
Accounting for Depreciation & Change of Method
This part explains how depreciation is recorded in the books:
Journal entries for charging depreciation
Impact on asset and profit and loss account
Change of method: How to adjust if a company switches from SLM to WDV (or vice versa)
You’ll also get practical examples to help you handle depreciation in accounting problems.
Provisions and Reserves – Meaning and Types
Apart from depreciation, businesses must prepare for future expenses or losses. That’s where provisions and reserves come in.
What is a Provision?
A provision is an amount set aside out of profits to meet a known liability or loss, the exact amount of which cannot be determined with substantial accuracy. Provisions are created to meet specific obligations or losses that are certain to occur but uncertain in amount.
Examples:
Provision for doubtful debts
Provision for tax
Provision for depreciation
Provisions reduce the current year’s profit directly.
What is a Reserve?
Reserves are amounts set aside out of profits to strengthen the financial position of the business, meet future contingencies, or for specific purposes. Unlike provisions, reserves are created voluntarily and represent appropriation of profits.
Types of reserves include:
General reserve – used for any future need
Specific reserve – for a particular purpose (e.g., dividend equalization reserve)
Capital reserve – created from capital profits (e.g., asset revaluation)
Difference Between Provisions and Reserves
Understanding the distinction between provisions and reserves is key:
| Basis | Provision | Reserve |
|---|---|---|
| Purpose | For expected losses/liabilities | For strengthening financial position |
| Impact on Profit | Reduces net profit | Appropriated after profit |
| Legal Requirement | Often required | Not always mandatory |
| Example | Provision for bad debts | General reserve |
This comparison helps you answer both theory and practical questions effectively.
Final Thoughts
Unit 3 helps you understand how businesses deal with the decline in asset value and prepare for future obligations through provisions and reserves. These concepts are fundamental to maintaining accurate and fair financial statements.
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