Depreciation Theory

  • Depreciation means a fall in the value of an asset because of its usage or with the efflux of time, or due to its obsolescence or accident.
  • Features of depreciation are reduces the book value of the asset and not its market value, reduces book value of an asset is permanent, gradual and has a continuing nature etc.
  • Depreciation is shown as expense and asset is shown with reduced value in the Balance Sheet.
  • Factors affecting amount of depreciation are cost of an asset, scrap value, useful life, legal provisions etc.
  • Depreciation is caused due to wear and tear, efflux of time, obsolescence, accident etc.
  • Objectives of charging depreciation are to show true and fair view of the financial position of the business, to ascertain exact cost of production, to provide funds for replacement of assets etc.
  • Depletion is used in place of depreciation in case of natural resources like mines, oil wells etc.
  • Amortisation means writing off the value of intangible assets.
  • Obsolescencerefers to decline in the value due to improved technique.
  • Different methods of providing depreciation are Straight Line Method, Diminishing Balance Method, Annuity Method, Depreciation Fund Method, Insurance Policy Method, etc.
  • Under straight line method a percentage of original cost of the asset is written off every year. This method is also called Equal Installment Method or Original Cost Method.
  • Under Diminishing Balance Method, depreciation is charged at fixed rate on the reducing balance every year. This method is based upon the assumption that the benefit accruing to business from assets keeps on diminishing as the asset becomes old.
  • The difference between straight line method and diminishing balance method is that, in case of straight line method the value of an assets can reduce to zero, while in case of diminishing balance method the book value of an asset can never be zero etc.
  • Asset account may be prepared with or without opening Provision for depreciationaccount.
  • Asset may be sold or discarded before or on the expiry of estimated useful life of the asset. In this case profit or loss on sale of asset is required to be computed. For this purpose sometimes assets disposal account is also opened.

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