Concept Of Depreciation
Every business acquires some non-trading fixed assets. These fixed assets are used in the business for facilitating its trading activities and enhancing its revenue earning capacity. These assets are basically purchased for the business with the intention of permanent use and not for resale.
All fixed assets except the value of land decreases with the passage of time. The value of these assets decrease each year. Such gradual reduction or decrease in the value of fixed assets for the purpose of earning revenue is called depreciation. Depreciation is closely related with the determination of profit or loss for the period. Unless depreciation is charged to the revenues, the true income of the business can not be ascertained properly. As such, depreciation is a revenue expense.
Fixed assets are also called depreciable assets. The characteristics of depreciable assets are as follows.
* The expected life of the asset is more than one accounting period.
* Those assets have a limited useful life.
* Those assets are held by the business for use in production of goods and services.
* Those assets are not for the purpose of sale in the ordinary course of business.
The cost of fixed asset indicates 'the price for the future service of the assets'. It is necessary to spread its cost over a number of years during which benefit of the asset is received. This process of allocating the cost of fixed assets is termed as 'depreciation'.
Meaning Of Depreciation
In general words, depreciation is the reduction in the value of an asset due to usage, passage of time, wear and tear, technological out dating or obsolescence, depletion, inadequacy, decay or other such factors.
In accounting, depreciation is a term used to describe any method of attributing the historical or purchase cost of an asset across its useful life, roughly corresponding to normal wear and tear. It is mostly used when dealing with assets of a short, fixed service life, and which is an example of applying the matching principle as per generally accepted accounting principles.
Depreciation is calculated on all depreciable assets which can be defined as those which have a useful life for more than one accounting period but is limited and are held by an enterprise for use in the production or supply of goods and services. Examples of depreciable assets are machines, plants, furniture, buildings, computers, trucks, vans, equipment, etc. Moreover, depreciation is the allocation of 'depreciable amount' which is the 'historical cost' or other amount substituted for historical cost less estimated salvage value.
Depreciation has significant effect in determining and presenting the financial position and results of operations of an enterprise. Depreciation is charged in each accounting period by reference to the extent of the depreciable amount.
In this way, depreciation is an allocation of the cost of assets over their useful life. A systematic procedure of for allocating the cost over the periods of its useful life in a rational manner is called depreciation accounting.
Features Of Depreciation
Following are the main features of depreciation:
1. Depreciation is decline in the book value of fixed assets.
2. Depreciation includes loss of value of assets due to passage of time, usage or obsolescence.
3. Depreciation is a continuing process till the end of the useful life of assets.
4. Depreciation is an expired cost and hence must be deducted before calculating taxable profits.
5. Depreciation is a non-cash expense. It does not involve ant cash flow.
6. Depreciation is the process of writing-off the capital expenditure already incurred.