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    Depreciation


    Depreciation
    The word depreciation is derived form a Latin word “Depretium” where “De” means decline and “pretium” means price. Thus, the word “Depretium” stands for decline in the value of assets. It stands for gradual and continuous decline. In simple words, Depreciation may be defined as permanent decrease in the value of assets due to Use and /or the lapse of the time.
    According to Carter, “Depreciation may be defined as the permanent and gradual decrease in the Value of assets from any cause.’’
    According to Spicer and Pegler,” Depreciation may be defined as measure of exhaustion of effective life of an asset from any cause during a given period.”
    From the above definitions, it is clear that depreciation is a decline in the book value of assets during the estimated useful life of the assets due to wear and tear, depletion, passage of time etc.

    Characteristics or Features of Depreciation
    a)      Depreciation may be physical and Functional.
    b)      It is a non cash expenses.
    c)       It is a charge against Profit.
    d)      Depreciation is charged in respect of fixed assets only.
    e)      Deprecation of an asset cannot exceed its depreciable value.
    f)       It is a process of allocation of cost and not of valuation of fixed assets.
            
    Causes of Depreciation
    The causes of decline on the book value of fixed assets may be divided into two categories:
    1)      Physical: Physical causes may be as follows
    a)      Wear and tear
    b)      Destruction
    2)      Functional: Functional causes may be as follows
    a)      Obsolescence
    b)      Inadequacy
    c)       Effluxion of time
    d)      Depletion
    e)      Exhaustion

    Objectives for providing depreciation
    a)      Recovery of cost incurred on fixed assets over their useful life for replacement of assets.
    b)      To find out correct cost of goods manufactured.
    c)       To find out correct profit for the year.
    d)      To provide for replacement of assets.
    e)      To find out correct financial position.
    f)       To reduce tax burden.

    Basic factors affecting the amount of depreciation
    a)      Cost of asset. The original cost paid on the acquisition of asset increased by amount spent on installation, freight, loading and unloading charges etc.
    b)      Estimated working life of the assets.
    c)       Estimated salvage/residual/ scarp value which is estimated to be realised when asset is sold.
    d)      Provision for repairs and renewals required to keep the asset in good condition.
    e)      Provisions of companies act, 1956 and income tax act, 1961 is considered.
    f)       Addition and subtraction during the life of the asset.
    g)      Obsolescence of asset due to change in technology.

    Methods of Depreciation
    Methods of Depreciation classified under the following groups:-
    (1)Uniform charge methods
    (a) Fixed installment method.
    (b) Depletion method
    (c) Machine hour rate method
    (2)Declining charged method
    (a)Diminishing balance method
    (b)Sum of years Digit method.
    (c)Double Declining method
    (3)Others method
    (a)Group Depreciation method
    (b)Annuity method
    (c)Inventory system of Depreciation
    (d)Insurance policy method

    Fixed installments and Diminishing balance method
    Fixed installments method
    Under this method depreciation is charged on original cost of the assets on uniform basis. The value of the assets can be reduced to ‘O’ under this method.
            Merits:        
    (1) It is simplest to understand and easy to apply.
    (2)The value of the assets can be reduced to zero under this method.
    Demerits:
    (1) Under this method, same amount of Depreciation is charged from year to year, irrespective of use of the assets.
    (2)With the passage of time efficiency of assets decreases but the amount of Depreciation remains the same.

    Diminishing Balance method
    Under this method a fixed rate of depreciation is charged each year on the diminishing value of the assets till the amount is reduced to scrap value.
    Merits:
    (1) The amount of depreciation decreases continuously with the decrease in the life of assets.
    (2) High amount of Depreciation is provided in earlier year thus reducing the impact of Obsolescence
    Demerits:
    (1) The book value of assets can never be zero.
    (2)The determination of a suitable rate of Depreciation is also difficult.

    Difference between Fixed installment method and reducing Installment method (Diminishing Balance method)
    (1)The rate and amount of depreciation remains the same each year under fixed installment method. But the rate remains the same, but amount of Depreciation reduces each year under reducing balance method.
    (2)Depreciation is calculated on original cost under fixed installment method. But, Depreciation is charged on the diminishing value of assets under reducing Balance Method.
    (3)The book value of assets reduces to zero under straight line method. But, the book value of assets can never be zero under reducing balance method.

    Some Important Points
    Depletion: - Depletion implies removal of available resources e.g. Coal from Coal mine, Oil out of Oil well. It is shown as revenue expenses in the profit and loss account.
    Amortization: - The process of writing off intangible assets such as goodwill, patents, and trademarks etc. is called Amortization. Intangible assets are those which cannot be seen or touched.
    Dilapidation: - The term Dilapidation refers to damage done to a building or other property during tenancy.
    Obsolescence: - When an asset becomes out dated due to new or improved technology or invention, this is called obsolescence.