Depreciation
Non- current assets are initially recognized at their historic cost i.e. actual cost price and any cost incurred in bringing asset in a ready-to-use state. They are recorded in subsidiary books such as cash book when bought cash and general journal when bored on credit.
They are then debited in the asset account on it cost price. Any additions are debited and should any of it or part of it be sold, a credit entry is created. The balance on this account will mean the value of the assets at historical cost at that particular time. Historical costs are used because they can be proven through the use of source documents.
Non-current asset cost cannot be treated the same as expense. This is simply because benefits from the asset is gained over the useful life of the asset which is more than a year. Matching concept states that expenses (costs) must be recorded in the same financial year as the income (benefit) to which it has been obtained from it. In short, revenue earned in a financial year must be matched with costs incurred in the same financial year. The concept implies that expenditure incurred during an accounting period should be matched with revenue collected during that time frame.
This is where depreciation fits in.
What is depreciation?
Depreciation is an estimate loss in value of a non-current asset as it is being put into use to generate income for the business over its useful life. With appreciation, we are trying to allocate the cost of an asset over it useful life after considering the fact that, the benefit of that asset is for more than one year.
It is an accounting method used to allocate the cost of asset over its useful life. It represents the value of the asset used up.
Causes of Depreciation- Constant UseThe value of a fixed asset can be reduced due to its constant use. This is because there is the possibility of normal wear and tear while using an asset for the business operations.
- Expiry of TimeGenerally, the value of an asset decreases with the passage of time even if they are not used for the once. Their values can get deteriorate due to natural factors such as rain, winds, weather, etc.
- Expiry of Legal RightsThere are certain assets which have a limited life span and after expiry of that span the value of the asset automatically get reduced. For example, lease. If a lease is obtained for 15 years for E6,00,000 then the value of lease will reduce every year whether the company uses it or not. So, at the end of the 15th year, the value of the lease will get reduced to zero.
- ObsolescenceThe inventions and improved technology are also a major cause of depreciation. With the innovation in the market, the old assets became obsolete and to remain in the market and face the market competition, the companies have to discard and replace these assets with the new one even if those assets can be put to use physically. Other than this, change in the customers' taste and preference also cause an obsolescence of the assets.
- AccidentSometimes, there can be loss of the machinery occur due to an accident or a natural calamity such as fire, theft, earthquake, flood, etc.
- DepletionThe continuous use of the certain assets also causes a reduction in the value of wasting assets such as mines, oil wells, etc. This is because these are the non-renewable resources, i.e., once they are finished can't be get or produced again.