what is depreciation :

the accounting process of gradually converting the unexpired cost of fixed assets into expenses over a series of accounting periods is called depreciation. the word 'depreciation' is derived from the Latin word 'Depretium' where 'De' means decline and 'pretium' means price.

characteristics of depreciation :

  1.  Depreciation is a non-cash expense.
  2. Depreciation may be physical or functional.
  3. Depreciation is a process of allocating costs and not valuing fixed assets.
  4. Depreciation is charged in respect of fixed assets only.
  5. Depreciation is a continuous fall in the utility of fixed assets till the end of their useful life.
  6.  it is charged to the revenue to find out the net profit of the business.
  7. Depreciation once charged can not be recouped afterwards.
causes of depreciation :

The causes of decline in the book value of fixed assets may be divided into two categories :

(1) physical (2) functional 

  • physical        
  1. Wear and tear. some assets physically deteriorate due to wear and tear in use. the constant use of assets wears out the asset. The more an asset is used, the greater would be the wear and tear.
  1. Destruction. The physical destruction of an asset reduces its utility value. The causes of destruction may be due to an accident like fire, flood, or similar other havoces or calamities.
  1. Decay. It refers to lessening in the utility of an asset by the effect of nature e.g. rain, moisture, change in weather, and other elements of nature.
  • functional 
The functional causes may be as follows :

  1. Obsolescence. some assets are discarded before they are worn out because of changed conditions. for example, an old machine which is still workable may have to be replaced by a new machine because of the later being more efficient and economical. such a loss on an account of new inventions or changed fashion is termed as a loss on account of obsolescence.
  1. Inadequacy. it refers to the termination of the use of an asset due to increase in the volume of business activities. Although the asset is still usable, its inadequacy for present level of activity has cut short its service life.
  1. Effluxion of time. there are some assets e.g. lease, patents, licences, copyrights, etc. which lose their value simply with the effluxion (passage) of time. Such assets become valueless after the expiry of period of their life.
  1. Depletion. In the case of oil wells, mines, etc. the value is reduced with the extraction of oil and minerals.
  1. Exhaustion. Assets like plantations, animals etc. lose their value gradually with the passage of time. They have their own age and exhaust in value after the expiry of certain period of their age.
Need for charging depreciation :
depreciation is recorded in the books due to the following reasons :
  1. Correct calculation of profits. One of the objectives of accounting is to determine the true profits of business. this purpose is achieved when depreciation is charged as an expense to the profit and loss account.
  1. True and fair view in balance sheet. If depreciation is not provided in the books of accounts, the fixed assets will be shown in the balance sheet at a higher value i.e., it will be overvalued. As such, this overvaluation of fixed assets will not represent a true and fair view of the state of affairs of the business.
  1. Accurate ascertainment of cost. For the manufacture of goods the plants, machinery, tools, equipment, etc., are required. Depreciation on these is a factory overhead, which must be included to find out cost of production accurately.