Depreciation means a fall in the value of an asset because of usage or with passage of time or obsolescence or accident. Every fixed asset looses its value, once it is put to use. It would be proper to consider some important definitions of depreciation.
“Depreciation may be defined as a measure of the exhaustion of the effective life of an asset from any cause during a given period.”
“Depreciation is the diminution in intrinsic value of the asset due to use and / or lapse of time.”
Here, it is important to note that depreciation is charged on all fixed assets except land. Usually the value of land appreciates over a period. The reason is that unlike other fixed assets like machinery, furniture it does not have finite economic life.
The above definition brings to highlight the following characteristics of depreciation:
Sometimes the terms depletion, obsolescence, amortization, etc., are used interchangeably with depreciation. But these terms are used in different contexts. Therefore, let us understand the basic distinction between depreciation and such other related concepts.
Depreciation and Depletion. The term ‘depletion’ is used in respect of the extraction of natural resources like quarries, mines, etc., that reduces the availability of quantity of the material of asset. Depreciation refers to a reduction in the value of all kinds of fixed assets arising from their wear and tear.
Depreciation and Obsolescence. Obsolescence refers to decrease in usefulness caused on account of the asset becoming out of date. Old fashioned, etc., Depreciation, as stated earlier, is a loss in value of an asset generally arising on account of wear and tear The fact remains that obsolescence is regarded as one of the causes of depreciation.
Depreciation and Amortization The distinction between depreciation and amortization is that ‘amortization’ refers to writing off the proportionate value of the intangibles such as goodwill, copyright, patents, etc., while ‘depreciation’ refers to the writing off of the expired cost of the tangible assets like, machinery, building, furniture, etc.
Wear and Tear. Wear and tear is an important cause of depreciation in the cases of tangible fixed assets. It is mainly due to use of the asset.
Efflux of Time. Some assets have a definite life period like a lease; on the expiry of the life the asset will cease to exist. Other assets, like plant and machinery, may not have a definite life; in their case the life is estimated.
Obsolescence. If a better machine comes in market, the old machines may have to be scrapped even though they are capable of being used. It is a reduction in usefulness of the asset.
Accounting Concept of Depreciation:- Accounting concept of depreciation means to distribute the cost of fixed assets as per its estimated life in a reasonable manner. According to this concept, in an accounting period, diminution in the value of assets can be charged to that accounting period,
Annual depreciation in the value of asses is like an expense which is due to use of assets in business functions and thus, is a charge on profits.
Therefore, this is an expense like other expenses. Its provision is not optional but compulsory. If we do not deduct any expense from the income of an accounting period, the ascertained profit will be wrong and will not disclose corrects result of the business.
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