Fundamentals of Financial and Cost Accounting · Financial Statements of Sole Proprietorship

Depreciation and Provisions: Methods, Provision vs Reserve and Examples

Updated 10 October 2026 · Fact-checked

Depreciation is the systematic charge of an asset's cost over its useful life. Straight line charges the same amount every year: (Cost − Scrap) ÷ Life. Written down value charges a fixed percentage on the opening book value. A provision is a charge against profit for a known liability or loss of uncertain amount. A reserve is an appropriation of profit.

Understand Depreciation and Provisions

Fixed assets such as machinery or furniture help a business earn for many years. You cannot charge the whole cost to one year. So you spread the cost over the years of use. This yearly charge is depreciation. It is a non-cash expense. It reduces profit and reduces the book value of the asset.

In the straight line method (fixed instalment), the charge is the same every year. In the written down value method (diminishing balance), the charge is a fixed percentage on the book value at the start of the year. So the charge is highest in year 1 and falls every year. Under straight line the rate is derived as annual depreciation ÷ original cost × 100. If a straight line rate is given in the question, apply it to original cost, or to cost less scrap if the question says so. Under WDV the rate applies to the reducing balance.

A provision is an amount charged against profit to meet a known liability or a likely loss, where the exact amount is not certain. Examples are provision for doubtful debts and provision for discount on debtors. It is a charge, so it is debited to Profit and Loss Account. A reserve is an amount set aside out of profit for strengthening the business or future needs. It is not a charge. It comes after profit is found.

Provision for doubtful debts is created on debtors after deducting actual bad debts. Provision for discount on debtors is created for cash discount you expect to allow to debtors who pay promptly. It is calculated on good debtors, that is, debtors after deducting bad debts and the provision for doubtful debts. In the balance sheet, provisions on debtors are deducted from debtors.

Key formulas to remember

Straight line depreciation per year: (Cost of asset + Installation cost − Scrap value) ÷ Useful life in years; Same amount every year. Add any cost needed to bring the asset into use.
Straight line rate: Annual depreciation ÷ Original cost × 100; The rate is derived from the annual charge. If a rate is given, apply it to original cost (or to cost less scrap if the question says so).
WDV depreciation per year: Opening book value × Rate % × Period ÷ 12; Book value = Cost − Depreciation charged so far. Scrap value is not deducted.
Book value at end: Opening book value − Depreciation for the year; This is the amount shown in the balance sheet.
Provision for doubtful debts: (Closing debtors − Additional bad debts) × Provision %; Charge to P&L only the change from the old provision: New provision − Old provision.
Provision for discount on debtors: (Debtors − Bad debts − Provision for doubtful debts) × Discount %; Applied on good debtors. Charge only the increase over the old provision; a decrease is a gain.
Provision versus reserve: Provision = charge against profit; Reserve = appropriation of profit; Provision reduces profit before it is found. Reserve is made out of profit.

How to solve Depreciation and Provisions questions

Use the same order for every question on depreciation or provisions.

1Read the data and note the date of purchase, the method and the rate or life.
2For depreciation, find the depreciable amount: cost plus installation, less scrap value if straight line is asked.
3Check the period. If the asset was bought or sold part-way through the year, charge depreciation only for the months used, unless the question says otherwise.
4Calculate the year's charge. For straight line, use (Cost + Installation − Scrap) ÷ Life, or apply a given rate on original cost. For WDV, apply the rate on the opening book value.
5For provisions, first deduct additional bad debts from debtors. Then apply the provision for doubtful debts. Then apply the discount percentage on what remains.
6Find the charge to P&L: new provision less old provision already in the books. If the result is negative, it is a credit to P&L.
7Show depreciation and provisions in the right place: depreciation in P&L and as a deduction from the asset, provisions in P&L and as a deduction from debtors.
8Check that the answer matches the option wording and units.

Quickest way: Option-check shortcut for MCQs

When to use it: Use this when the question gives numbers and four options and you have about one minute per question.

Decide the method first. Same amount each year means straight line. Percentage on a reducing balance means WDV.
For straight line, compute (Cost + Installation − Scrap) ÷ Life and match it to the options.
For WDV, do year 1 as Cost × Rate. Year 2 is always lower than year 1. Eliminate any option equal to year 1.
For provisions, write the three-line chain: Debtors − Bad debts, then − Provision for doubtful debts, then × Discount %.
Remember that P&L shows only the change from the old provision. Eliminate options showing the full new provision when an old balance exists.

Common mistakes in Depreciation and Provisions

Deducting scrap value in the WDV method
Students carry the straight line formula over to WDV.
Fix: In WDV the rate is applied on book value. Do not deduct scrap value from it.
Applying the straight line rate on the reducing balance
The word 'rate' makes students apply it on the current balance.
Fix: Straight line: rate on original cost every year. WDV: rate on opening book value.
Ignoring part-year use
Students rush and give a full year's charge.
Fix: If an asset is bought on 1 October and the year ends 31 March, charge six months, which is Rate × 6 ÷ 12.
Charging the full new provision to P&L
Students forget the old provision already in the books.
Fix: Charge only new provision minus old provision. If the new one is lower, the difference is a gain.
Calculating discount provision on total debtors
Students skip the deduction of bad debts and provision for doubtful debts.
Fix: Discount is expected only on good debtors. Deduct both first, then apply the percentage.
Treating a reserve as a charge against profit
Provision and reserve sound similar.
Fix: A provision is charged before profit is found. A reserve is set aside out of profit after it is found.

Worked examples

Example 1

A machine costing ₹1,00,000 was bought on 1 April 2025. Its scrap value is ₹10,000 and its life is 5 years. Another machine costing ₹1,00,000 is depreciated at 20% on WDV. Find the depreciation of each machine for the second year (year ending 31 March 2027) and the book value of the WDV machine at its end.

Show the solution

Straight line depreciation = (1,00,000 − 10,000) ÷ 5 = ₹18,000. It is the same every year, so the second year is ₹18,000.
WDV year 1: 20% of 1,00,000 = ₹20,000. Book value at end of year 1 = ₹80,000.
WDV year 2: 20% of 80,000 = ₹16,000.
Book value at end of year 2 = 80,000 − 16,000 = ₹64,000.

Answer: Straight line depreciation for year 2 is ₹18,000. WDV depreciation for year 2 is ₹16,000, and the book value at the end is ₹64,000.

Example 2

On 31 March 2027 a trader's debtors are ₹1,10,000. Further bad debts of ₹10,000 are to be written off. A provision for doubtful debts of 5% and a provision for discount of 2% on debtors are to be made. The books show an old provision for doubtful debts of ₹3,000 and an old provision for discount of ₹1,000. Find the amount charged to P&L for each provision.

Show the solution

Debtors after further bad debts = 1,10,000 − 10,000 = ₹1,00,000.
New provision for doubtful debts = 5% of 1,00,000 = ₹5,000.
Charge to P&L = 5,000 − 3,000 = ₹2,000.
Good debtors = 1,00,000 − 5,000 = ₹95,000.
New provision for discount = 2% of 95,000 = ₹1,900.
Charge to P&L = 1,900 − 1,000 = ₹900.

Answer: The charge is ₹2,000 for doubtful debts and ₹900 for discount. The balance sheet shows debtors of ₹1,00,000 less ₹5,000 and ₹1,900, giving ₹93,100.

Exam tips

Read whether the question says straight line or WDV before doing any calculation.
Watch for a purchase date during the year. Part-year depreciation is a common trap in options.
For provisions, always look for an old provision in the trial balance. The P&L charge is the difference.
Remember the order: bad debts, then doubtful debts provision, then discount provision.
Write the book value of the asset when the question asks for the balance sheet figure, not the depreciation.

Practice questions from Financial Statements of Sole Proprietorship

Depreciation and Provisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Depreciation and Provisions: frequently asked questions

What is the difference between straight line and written down value method?

Straight line charges the same depreciation every year, based on original cost less scrap value. WDV charges a fixed percentage on the reducing book value, so the charge falls each year. Straight line is simpler. WDV gives a higher charge in the early years.

What is the difference between a provision and a reserve?

A provision is charged against profit to meet a known liability or likely loss whose amount is uncertain. A reserve is an amount set aside out of profit for future needs or to strengthen the business. Provision reduces profit. Reserve is an appropriation of profit.

How is provision for discount on debtors treated in final accounts?

Calculate it on good debtors, after deducting bad debts and the provision for doubtful debts. Charge only the increase over the old provision to the Profit and Loss Account. In the balance sheet, deduct it from debtors.

Is scrap value used in the WDV method?

No. In WDV you apply the rate on the opening book value and do not deduct scrap value. The scrap value matters in the straight line formula.