10.

1 CONCEPT OF DEPRECIATION

Every firm acquires different types of assets for starting its operations and these assets can be
broadly classified into fixed and current assets. Fixed assets are generally used for a longer
period; these include machinery, plants and buildings. These assets are not meant for resale,
but this does not mean that their value will always remain the same. It means that fixed assets
lose their value over time. Therefore, a firm will distribute the cost of fixed assets over time in
the form of Depreciation.

According to the Institute of Chartered Accountants of India, “Depreciation is a measure of the

wearing out or other loss of value of a depreciable asset arising from use, time or obsolescence.
Depreciation is allocated so as to charge a fair proportion of the cost in each accounting period
during the expected useful life of an asset”.
Depreciation revolves around three important aspects of an asset:
 Cost of the asset
 Estimated life of the asset (no. of years)
 Residual value of the asset

10.1.1 Features of Depreciation

The definition of depreciation given by the Institute of Chartered Accountants of India reveals
the distinguishing features of the term ‘Depreciation’. These features of depreciation are
described below:
i. Depreciation denotes Loss of value, which implies a fall in the value of assets.
ii. Depreciation is related to tangible fixed assets.
iii. The fall in the value of assets is due to the regular use of the asset in business
operations.
iv. Depreciation represents the gradual, continuous and permanent fall in the value. The
fall in the value is because of depletion and obsolescence.
v. Depreciation should be provided in each accounting year during the expected useful life
of the asset.
vi. Depreciation is a non-cash expense and represents the reduction in the value of an asset
due to wear and tear, age or obsolescence.
For the loss in the value of intangible assets, such as patents and copyrights, amortisation is
used.

10.1.2 Factors of Depreciation

 Physical
Deterioration

Obsolescenc Depreciatio Inadequac

e n y

Depletion

Figure 10.1 Factors Causing Depreciation of Assets

There are mainly four factors that lead to the depreciation of fixed assets. (Figure 10.1) These
four factors are explained as follows:
i. Physical Deterioration - This occurs in two ways: (1) by the continuous and gradual use
of the asset that renders fixed assets useless. This is known as wear and tear of assets.
(2) Natural deterioration occurs through rust and rot. This happens mainly in the case of
metal assets, including vehicles and machinery.
ii. Obsolescence - This makes the asset out of date. By the passing of each day, new
technologies are being introduced in the market, making the old one obsolete. The
simplest example is replacement of typewriters by computers.
iii. Inadequacy - This is the incapability of a machine due to the increased capacity of a
firm. With an increase in size, firms expand their operations, which will further put
pressure on the productivity of an asset. If the asset cannot meet the existing demand
of a firm, it is considered as inadequate.
iv. Depletion - Mainly natural assets that include oil wells and mines get depleted with
time, due to the extraction of raw resources from them.