DEPRECIATION

Depreciation is the decrease of worth of fixed assets with the passage of time and use. It is derived from
the Latin word depretium, which means declining worth. Depreciation may be found in form of physical
depreciation, economic depreciation and accounting depreciation etc.

Depreciation is a permanent continuing and gradual shrinkage in the book value of fixed asset. It is
charged on the fixed assets only. The institute of Chartered Accountants of India defines depreciation as
a measure of the wearing out consumption or other loss of a value of a depreciable asset arising from
use, affluxion of time or obsolescence through technology and market changes.

Needs for depreciation:

a) It is necessary to ascertain true profit or net profit of a business.

b) It represents true and fair view of financial position.
c) It assures the exact cost of production
d) It is necessary to comply legal requirements
e) It is needed to accumulate funds for replacement of assets

Features of depreciation:

a) It is non cash expanses

b) It may be physical or functional
c) It is a process of allocation of cost
d) It is charged on fixed assets
e) It shows the financial strength of a firm
f) It does not depend upon the fluctuation of market prices

Causes of depreciation

i) Physical depreciation: It is caused mainly by wear and tear of the asset in the normal production
process. erosion, rust and decay are causes of depreciation also.

ii) Accidents: It is another important contributing factor to depreciation. The value of fixed assets
decline due to break down, loss by fire etc.

iii) Absolenscence: Depreciation also starts due to absolenscence. It means because of technological
advancement, the assets in use may become out dated and loose a larger part of its value.
Inadequacy refers to the termination of the use of an asset because of growth and changes in the
size of the firm.

v) Time factor: There are certain assets with a fixed period of legal life such as lease, patent and
copyrights. For instance, a lease can be entered into for any period while a patent’s legal life is for
 some years but on certain grounds this can be extended. Provision for the consumption of these
assets is called amortization rather than depreciation.

vi) Depletion: Some assets are of a wasting character perhaps due to the extraction of raw-materials
from them. These materials are then either used by firm or sold. Natural resources such as mines,
quarries and oil wells come under this segments. The declining value of asset due to some extraction
is called as depletion.

DEPRECIATION VS OBSOLESCENCE

Depreciation is a permanent continuing and gradual shrinkage in the book value of fixed asset. It is
charged on the fixed assets only. The institute of Chartered Accountants of India defines depreciation as
a measure of the wearing out consumption or other loss of a value of a depreciable asset arising from
use, efflux of time or obsolescence through technology and market changes.

Obsolescence is one of the causes of depreciation; other causes may be wear and tear of the asset,
Accidents, elapsmement of time, Depletion etc. Obsolescence means because of technological
advancement, the assets in use may become out dated and loose a larger part of its value. Inadequacy
refers to the termination of the use of an asset because of growth and changes in the size of the firm.

 Salvage Value (SV): The estimated value of a property at the end of its useful life. It is the
expected selling price of a property when the asset can no longer be used productively by its
owner. The term net salvage value is used when the owner will incur expenses in disposing of
the property and these cash outflows must be deducted from the cash inflows to obtain a final
net SV. Under MACRS the SV of a depreciable property is defined to be zero.

Straight Line Method of Depreciation (SLM)

Meaning under the straight line method, a fixed and equal amount in the form of depreciation,
according to a fixed percentage on the original cost, is written off during each accounting period
over the expected useful life of the asset.

How to calculate the Rate of Depreciation under SLM: The rate of depreciation is calculated as follows:
Written Down Value Method (WDV)

In this method rate of depreciation falls on WDV of the assets and the rate of depreciation is calculated
by the following formula:

where r = W.D.V rate of Depreciation

S = Salvage value

C = Original cost of the asset.

Units-of-Production Method

• The depreciation rate under this method is determined by

• dividing the net acquisition or construction cost

(i.e. acquisition or costs minus salvage value) by

the estimated number of units that are likely

to be produced during its useful economic life.

This rate is then applied to the number of units produced during an accounting period to determine
the depreciation to be provided during that period.