Introduction
Depreciation is a term used in accounting, economics and finance to spread the cost of an asset over the span of several years. In common, depreciation is the reduction in the value of an asset used for business purposes during certain amount of time due to usage, passage of time .In this chapter we are going to learn about depreciation in detail and also about the methods to calculate depreciation.Learning Objectives
After studying this Chapter, you will be able to:- Understand the meaning and definition of depreciation.
- Recognize the reasons and causes for providing depreciation.
- Identify various methods of depreciation.
- Determine the profit or loss at the time of sale of asset.
Depreciation
All assets whose benefits are derived for a long period of time, usually more than one year period are called as Fixed Assets. These assets decrease in value year after year due to wear and tear or as time passes by. This reduction in value of Fixed Assets is called Depreciation.For instance, a factory owner owns machinery worth Rs.5, 00,000, may estimate the life of the machinery as ten years. This means that the value of the asset is reducing every year. Hence, it is necessary to spread the cost over five years during which the benefit of the asset is derived. Thus depreciation Rs.50,000 (Rs.5, 00,000 /10 years) is to be treated as an expense, which is debited to Profit and Loss account.
In the words of Spicer and Pegler, “Depreciation is the measure of the exhaustion of the effective life of an asset from any cause during a given period”.
Causes of Depreciation
The causes of depreciation may be internal or external. The internal causes arise from properties inherent in the asset itself. External causes arise from forces outside the business. These are being discussed below:
Internal Causes
- Wear and tear: Wear and tear means decrease in assets value, arising from its use in business operations
- Disuse: When a machine is kept continuously idle, it becomes potentially less useful.
- Maintenance: when the machine is not maintained properly its condition deteriorates
- Depletion: depletion physical reduction of natural resources by exhaustion e.g., mines, quarries, oil wells etc.
External Causes
- Obsolescence: Decrease in value of property as the result of technological advancement.
- Effluxion of time: When assets are exposed to forces of nature, like weather, wind, rain, etc., the value of such assets may decrease even if they are not put into any use.
- Time Factor: Lease, copy-right, patents are acquired for a fixed period of time. On the expiry of the fixed period of time, the assets cease to exist.
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