Life span of an asset to a firm rests primarily, on the purpose of its acquisition and secondary, on its nature. An item acquired for immediate consumption or sale is a short-lived asset and that meant for prolonged use, is long lived asset, though both yield revenues. Whereas the former asset expires within one year of its acquisition, the latter asset lasts longer. Hence approximately whole expenditure on a short lived asset becomes an price and is matched against current year's revenue.
But the position is otherwise with a long-lived asset which wears out or depreciates over a long period. Accordingly, the outlay of a fixed asset is spread over any years and annually only a fraction thereof expires. Simply, this fraction, called expired cost or depreciation, is expensed against current revenues and the rest, termed un expired cost, is carried transmit for future expiration.
"Depreciation may be defined as the permanent decrease in the value of an asset due to use and/or the lapse of the time." -Terminology of compose of Cost and supervision Accountants, England
"Depreciation is the permanent and continuous diminution in the quality, quantity or value of an asset." -Pickles
"Depreciation may be defined as portion of the exhaustion of efficient life of an asset from any cause while a given period." -Spicer and Pegler
"Depreciation is' the gradual and permanent decrease in the value of an asset from any cause."-Carter
Objects of production provision for depreciation
For attaining following objects, depreciation accounting is a must for every business:
(1) rescue of cost incurred on fixed assets over their beneficial life so as to keep owner's capital intact;
(2) Provision is for exchange cost on the withdrawal of original assets ;
(3) to consist of the depreciation in the cost of output to find out the spoton cost of production;
(4) to find out spoton profit for the year ;
(5) to find out the spoton financial position straight through equilibrium sheet.
Causes of Depreciation
Depreciation may be of two types :-
(1) Internal-Depreciation which occurs for inescapable inherent general causes is known as internal depreciation. The causes of internal depreciation are :
(1.1) Wear and Tear-An asset declines on catalogue of prolonged use e.g. Building, plant,
machinery etc. Such decline depends upon portion of use of an asset. If a installation works double-shift instead of single shift, depreciation on plant and machinery will be doubled. It is inescapable that such loss is unavoidable. An asset may be kept in proper working conditions
through repairs for the time being, but it can not be done so permanently: At one time the asset will become unfit for repairs, when it will no longer be suitable.
(1.2) Depletion-Some assets decline in value proportionate to the portion of production, e.g. Mines, quarry etc. With the raising of coal etc. From coal mine, the total deposit reduces gradually and after some time it will be fully exhausted. Then its value will be nil.
(2) External-Depreciation caused by some external reasons is called external
depreciation.
The causes of external depreciation are:
(2.1) Obsolescence
Some assets, though in proper working order, may become obsolete. For example old machine becomes obsolete with the invention of more economical and sophisticated machine, whose efficient capacity is generally higher and cost of output is lesser. In order to survive in the competitive store the maker must setup new machine replacing the old one.
(2.2) tube of time
Some assets diminish in value on catalogue of sheer tube of time, even though they are not used e.g. Lease hold property, patent rights, copy possession etc.
(2.3) Accidents
Assets may be destroyed by abnormal reasons such as fire, earth quake, flood etc. In such a case the destroyed asset may be written-off as loss and a new one purchased.
Need for Provision of Depreciation
The need for provision for depreciation arises for the following reasons:
(1) Ascertainment of true profit or loss-Depreciation is a loss. So unless it is carefully like all other expenses and losses, true profit/loss cannot be ascertained. In other words, depreciation must be carefully in order to find out true profit/loss of a business.
(2) Ascertainment of true cost of production-Goods are produced with the help of plant and machinery which incurs depreciation in the process of production. This depreciation must be carefully as a part of the cost of output of goods. Otherwise, the cost of output would be shown less than the true cost. Sale price is usually fixed on the basis of cost of production. So, if the cost of output is shown less by ignoring depreciation, the sale price will also be fixed at a low level resulting in loss to the business;
(3) True Valuation of Assets-Value of assets gradually decreases on catalogue of depreciation. If depreciation is not taken into account, the value of asset will be shown in the books at a frame higher than its true value and hence the true financial position of the firm will not be disclosed straight through equilibrium Sheet.
(4) exchange of Assets-After some time an asset will be thoroughly exhausted on catalogue of use. A new asset then be purchased requiring large sum of money. If the whole number of profit is withdrawn from firm each year without inspecting the loss on catalogue of depreciation, valuable sum may not be available for. Buying the new assets. In such a case the required money is to be collected by introducing fresh capital or by obtaining loan by selling some other assets. This is contrary &0sound industrial policy.
(5) holding Capital' Intact-Capital invested in buying an asset, gradually diminishes on
account of depreciation. If loss on catalogue of depreciation is not carefully in determining profit/ loss at the year end, profit will be shown more. If the excess profit is withdrawn, the working capital will gradually reduce, the firm will become weak and its profit earning
capacity will also fall.
(6) Legal Restriction-According to Sec. 205 of the fellowships Act, 1956 dividend cannot be declared without charging depreciation on fixed assets. Thus in "Case of joint stock fellowships charging of depreciation is compulsory.
