Accounting Reserves: Concept

Several times we have heard the word reserve in accounting but the exact meaning…

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Several times we have heard the word reserve in accounting but the exact meaning is at times not explained in various accounting classes and also most of the classes are not covering in the accounting courses. And even if it is explained in various accounting classes by learned faculties, students fail to understand the basics. They know it’s accounting effect. Do they really know what is it? Or why it is created for?

Let us understand the concept of reserves and their types:

Profit earned by any business is payable to its proprietor. But the proprietor does not withdraw the whole amount of profit. He leaves some amount of profit to maintain the liquidity and strengthen the financial position of the business. This amount is known as the reserve. Reserve is profits, appropriated for a particular purpose.

There is a long list of reserves created for in the books of accounts as explained in various accounting classes. And truly, it is so. However, primarily we can classify reserves in two categories:

  • Revenue reserve
  • Capital reserve

Revenue reserves can be further classified into:

  1. General reserve: Profit determined by the profit and loss statement at the end of the year, the proportion of such profit is not aid to the proprietor, but kept apart is known as revenue reserve. General reserve is created to maintain the liquidity of the business resources, meeting any known contingencies, liabilities, etc.
  2. Specific reserve: If the provision is created for any specific period it is known as a specific reserve. This reserve cannot be utilized for any other purposes. For example- Reserve for Repairs and Maintenance, Reserve for Outstanding Expenses.

On the other hand, Capital Reserve refers to the profit that arises from the sources other than the normal trading activities. Such profit is known as capital profit. A capital reserve is an account on the balance sheet which can be used for contingencies or to offset capital losses. It is built out of capital profit and not out of business profit.

Hence, we can infer that reserve is a great source for financing any long-term project of any company, and if a company which isn’t keen to go for debt, term loan etc. can use this reserve to fully finance their new projects. There are many sub-classifications we focus during our accounting classes on reserves. For more such details you can attend our free demo classes.

Understanding Methods of Depreciation

Generally, methods for providing depreciation are based on the formula developed on a study of…

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depreciation method - Best accounting classes in ahmedabad

Generally, methods for providing depreciation are based on the formula developed on a study of the behavior of the assets over a period of years for readily computing the amount of depreciation suffered by different forms of assets. However, various accounting institutes focus on a few methods and overlook the other methods. Due to space constraint, we will explain only two most commonly used depreciation methods here.

The two methods for providing depreciation are the Straight Line Method and the Reducing Balance Method. The Straight Line Method is the most suitable and accurate method to adapt in most case. The income tax rules, however, prescribe the Reducing Balance Method except in the case of assets of an undertaking engaged in generation and distribution of power.

Straight Line Method: An equal amount is written off every year during the working life of an asset so as to reduce the cost of the asset to nil or its residual value at end of its useful life. The advantages of this method are that it is simple to apply and give accurate result results especially in the case of leases, patent and copyrights, and also in case of plant and machinery. This method is even known as Fixed Instalment Method.

Methods of Depreciation - best tally classes in ahmedabad

So, it is very simple. And it is like apportioning some expenses every year. So, no need to attend any accounting institute for this purpose.

Reducing Balance Method: Under this method, a fixed percentage of diminishing value of the asset is written off each year, so as to the asset to its break – up value at the end of its life, repairs and small renewals being charged to revenue. This method is commonly used for plants, fixtures, etc. Under this system, the annual charge for depreciation decreases from year to year, so that the earlier years suffer to the benefit of the later years. Also, under this method, the value of the asset can never be completely extinguished, which happens in the early explained Straight Line Method.

Many accounting institutes and academies stop at this juncture instead of teaching students exact formulae of arriving at the proper depreciation rate. But our accounting training in Ahmedabad focuses on every nitty-gritty of this method since this method is generally the only allowed method of calculating income tax applicable to the firm.

In this method, Depreciation goes on decreasing every year. The formula is –

best accounting classes in ahmedabad 2018-12-19

Suppose that the fixed asset purchase price is 10,000, the scrap value is 1,000, and the depreciation rate is 30%.

Using the Reducing balance method, 30% of the depreciation base (net book value minus scrap value) is calculated at the end of the previous depreciation period. Calculation of depreciation for the first three years is shown in the following table.

Understanding Methods of Depreciation - accounting classes in ahmedabad

If you have any questions related to this topic, we will be happy to revert to you or you can visit our accounting institute in Ahmedabad and attend a free demo class of depreciation accounting.