Depreciation
The non-trading fixed assets of a business like land, building, machinery, furniture etc. may be get depreciated in value due to various reasons. In other words, the value of such assets reduces each year due to use. Such gradual ad permanent reduction in the value of the assets due to wear and tear or from any other causes is called Depreciation. The word depreciation is derived from a Latin work 'Depretium' which is composed of two words 'De' and 'Pretium', where 'De' denotes decrease and 'Pretium' denotes price. Thus, the word depreciation means decrease in the price. It indicates a fail in the value of an asset which is a loss or an expense for a business and shown in the debit side of profit and loss account. It must be deducted from the respective assets in the balance sheet.
According to J.R. Batliboi,"Depreciation means permanent decline in the value of assets due to wear and tear or from any other cause."
According to R.G. Williams,"Depreciation may be dfined as a gradual deterioration in value of assets due to use."
Causes of Depreciation
1. Wears and Tears: The value of an asset declines due to its constant use in the business. Generally, fixed assets are depreciated due to wear and tears which means reduction in the efficiency and value of an asset caused from vibration, friction, accident, movement, erosion etc.
2. Innovation: Due to the development of science and technology, the new and improved automatic machines may be invented. Such invention reduces in the value of old and existing machinery.
3. Expiry of Time: The value of some assets like patent right, copy-right, lease hold property etc. decrease with the passage of time. The right of such assets is predetermined for certain duration. After its expiry, there is no value even it is not used.
4. Exhaustion: The value of some assets like mines and quarries go on declining with the continuous use.
5. Fall in market price: Another reason of depreciation is permanent fall in the price of an asset. The value of asset reduces as the market price of an asset continuously goes on declining.
Objectives for providing depreciation
1. For the replacement of assets: The fund equal to the amount of the depreciation is created which will remain in the firm. After the expiry of the life of asset, the same fund can be utilized to replace the new asset.
2. For the determination of true profit or loss: Depreciation is also an expense like repair and maintenance which must be included in profit and loss account to ascertain the correct profit or loss of a business for the year.
3. For the presentation of assets in the balance sheet at their proper value: Depreciation must be charged to each fixed asset for the true and fair presentation of assets in the balance sheet. The depreciation is deducted from the cost or book value of assets each year.
4. For the determination of correct cost of production: Correct cost of production can not be ascertained if the depreciation is not charged to the fixed assets. Thus, it is necessary to include amount of depreciation in the calculation of cost of each product.
Factors affecting the amount of Depreciation
a) Original cost of the assets: Original cost includes the purchase price of the asset plus freight and installation expenses. Depreciation is charged on cost of asset so, it is found as:
Cost of Asset = Purchase price Freight (Transportation expenses) Installation (erection) expenses
b) Estimated working life of the asset: All the fixed assets have their working life which can be estimated but not predetermined. After this period, the assets will be worthless or scrap. The working life of asset plays vital role in the determination of depreciable amount.
c) Scrap value: Scrap value is also called as salvage or residual or terminal value which means to the value that will be realized by selling the asset after the expiry of the estimated working life. Such amount must be deducted in cost of assets in the calculation of depreciation.