Definition of Provision for Depreciation or Accumulated Depreciation or (Difference between Depreciation and Provision for Depreciation):
Depreciation is an expense which is charged in the current year’s income statement; however, depreciation is not deducted from non-current assets directly. Depreciation is instead recorded in a contra asset account, namely provision for depreciation or accumulated depreciation.
This provision for depreciation is then subtracted from the original cost of a non-current asset, to calculate net book value.
It is not less important to understand that the provision in a balance sheet represents total reduction in the value of non-current assets from their dates of acquisition to the end of the current year.
Annual depreciation charge is an expense and has a debit nature, whereas; provision for depreciation as a contra asset has a credit balance.
Further difference between depreciation or annual depreciation and provision for depreciation or accumulated depreciation, can be explained with the help of following solved examples.
Solved Example 1:
Jack decides to start a new business and on 1st January 2019 buys a machine at a cost of $12000. He decides to depreciate the machine @40% p.a. by using reducing balance method.
(a) Calculate annual depreciation charge in the income statements for each of the two years ended 31 Dec 2019 and 31 Dec 2020.
(b) Show the entries to be made in machinery account, provision for depreciation of machinery account in Jack’s ledger for each of the two years.
Solved Example 2 – Provision for Depreciation:
A vehicle was purchases on 1st January 2019 for $50000. Depreciation is charged @10% p.a. by using straight line method. On 31 Dec 2021, the sale value would be estimated for $24000.
Show the entries to be made in machinery account, provision for depreciation of machinery account for each of the three years ending 31 Dec 2019, 31 Dec 2020 and 31 Dec 2021.
In the above example the machine disposal account showed a debit balance of $11000 which represents loss on disposal as the selling price is less than the book value ($50000 – $15000) of the asset sold. This debit balance is closed to the income statement by making the following entry: