DEPRECIATION

DEFINITION OF DEPRECIATION

Depreciation may be defined as gradual and permanent decline in the value of fixed assts as a result of wear and tera , obsolescence or for any other reasons.

The name "depreciation" comes from the latin word "Depretum" that means "Reduction of values", so depreciation means the reduction in the value of assets which has to be considered for determining revenue.

Indian accounting standard (AS-6) states that "Depreciation is allocated" so as to change a fair proportion of depreciable account in each accounting period during the expected useful life of the asset.

DETERIORATION & OBSOLESCENCE

When a new technology or technical knowledge , how to capture the market and on account of that , existing assets losses its value is known as Obsolescence.

                                                                                            Obsolescence is a type of loss which may occur within a short-time and as a obsolescence means a change in technology. A fixed amount of loss due to obsolescence can not be determined accurately.

So innovation of better substitutes , changes in market demand , imposition of legal restriction may result into discarding of assets or obsolescence.

CAUSES OF DEPRECIATION

Internal

• Wear and tear :- When fixed assets are put to use the value of such assets may decrease. Such decrease ion the value of assets is said to be due to physical war and tear like plant & machinery , furniture , motor vehicles , etc. suffers from loss of utility due to negligent handling, rusting etc.

• Depletion :- Non-renewable resources (like wines) decreases with regular extractions

External or economic cause :- 

• Obsolescence :- When a new technology captures market and on the account of that existing assets losses its value is known as Obsolescence.

• Inadequacy :- Changes in the scale of production or volume of activity may lead to discarding an asset.

Time element :- Wit the passage of time some intangible assets (fixed) like lease , patents , copy-rights etc. lose their values or effectiveness whether used or not the word "Amortization" is a better term to speak for the gradual fall in their values.
Abnormal occurrences :- an accident fire or natural calamity can damage the service potential of an asset partly or fully . As a result effectiveness of the asset is affected and reduced.

STRAIGHT LINE DEPRECIATION OR FIXED OR EQUAL TNSTALMENT DEPRECIATION

It is the simplest and most popular method of depreciation  provision. In straight line method , we need 3 things namely -

• The initial cost of the asset

• The useful life in years 

• Salvage value at the end of the useful life

 FEATURES :-

• A fixed portion of the cost of a fixed asset is allocated and charged as periodic Depreciation

• Such depreciation becomes or equal amount in each period.

           

APPLICABILITY

This method is applicable for an asset whose working life can be reasonably estimated ; which will not need much repair works and which is not likely to be obsolete , for example :- Patents , Copyright , Trade marks , Leasehold assets etc.

MERITS:-

• The calculation of depreciation is very simple. 

• The book value of an asset can be fully written off.

DEMERITS :-

• With gradual use , the usefulness of an asset is reduced , But the amount of depreciation remains uniform throughout its working life.

• It does not consider the interest on the capital invested for the asset.