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Why is Depreciation Charged on Assets

What is meant by Depreciation?

Depreciation means reduction in the value of a fixed asset used in the business due to and effluxion of time.

A reduction in the value of an asset over time, due in particular to wear and tear.

What is depreciation?

:

i. Wear and tear: Caused mainly due to constant use, erosion, rust etc.

ii. : Mere passage of time will cause a fall in the value of an asset, even if it is not used.

iii. : A new invention or change in fashion or a permanent change in demand may render the asset useless.

iv. : When raw materials or natural resources like mines, quarries and oil wells are extracted continuously, they deplete.

v. : An asset may reduce in value because of meeting with an accident, like fire accidents.

vi. Fall in the market price.

What is the necessity for providing depreciation?

According to International Standard Committee (IASC) “Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life. Depreciation for the accounting period is charged to income either directly or indirectly.”

The arises because of the following reasons:

  • To ascertain the true profit of the business for a particular period
  • To show the asset at its true value in the balance sheet
  • To provide funds for replacement of the old asset with a new one

Objectives of providing depreciation:

  1. To recover the cost incurred on fixed assets over its life
  2. To facilitate the purchase of new asset, when the old asset is disposed
  3. To find out the correct profit or loss for the particular period
  4. To find out correct financial position through balance sheet

Factors to be considered while determining the amount of depreciation:

I. The total cost of the asset including all , and installation charges

II. The estimated residual or scrap value at the end of its life

III. Estimated number of years of its usefulness

The term depreciation is concerned with charging the cost of fixed assets to operations. But the term depletion refers to the cost allocation for natural resources, whereas the term amortization relates cost allocation for intangible assets.

What are the various methods for depreciation?

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