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It is a noncash expense that reduces the value of an asset as a result of wear and tear, ageing, or obsolescence. Most assets lose their value over time and must be replaced once the end of their useful life is reached. There are several accounting methods that are used in order to write off an asset’s depreciation cost over the period of its useful life. Because it is a non-cash expense, iit lowers the company’s reported earnings while increasing free cash flow.
It must be noted that it is charged on almost every kind of fixed assets except land. Usually the value of land appreciates over a period. The reason is that unlike other fixed assets like Plant & Machinery, furniture it does not have finite economic life.
Characteristics
– Depreciation, in the case of fixed assets is charged only as buildings, plant and machinery, furniture, etc. There is no question of attribution in the case of current assets, such as stock, accounts receivable, change in ownership, etc.
– It causes permanent, gradual and continuous decline in the value of the bond
– It is computed until the last day of the estimated working time life of an asset
– Depreciation account is created for asset used, however depreciation can occur even if the assets is not used. For example, leasehold property, patents, copyrights, etc.
– It is against the revenue of an accounting period
– It does not depend on fluctuations in the market value of the bond
– Amount of the depreciation of an accounting year cannot be accurately determined, it must be estimated. However, in certain cases it can be determined accurately, e.g. leasehold property, patents, copyrights, etc.
Causes
– Wear and Tear
– Efflux of time
– Loss of attractiveness
– Obsolescence
– Accidents
– Fall in market prices
Objectives of charging depreciation
It is very unfortunate that depreciation is not visible like other expenses till the very end. In case of other expenses, the expenditure is obvious, but it is not so with depreciation. Also many people do not deduct depreciation from the gross earning to ascertain their net profit simply because there is no payment for it. This gives a misleading financial position of the firm.
