WHAT IS DEPRECIATION?
This is the term used to indicate a loss in the money value of the asset due to age and usage. It may be due to normal wear and tear due to usage, or due to deterioration and decay on account of the aging process since its creation. It could be due to obsolescence and inadequacy of the asset. Depreciation is an important concept, which enables a person to find out wearing out of the capital value of an asset whether it is a movable asset like machinery, vehicles, or an immovable asset like buildings. The land is considered to be a depreciable asset, though some land does depreciate in value because of erosion or damage to land due to natural forces like earthquakes and Tsunami. The depreciation term is used to indicate a loss in the money value of the asset due to age and usage. It may be due to normal wear and tear due to usage, or due to deterioration and decay on account of the aging process since its creation. It could be due to obsolescence and inadequacy of the asset. Depreciation is an important concept, which enables a person to find out wearing out of the capital value of an asset whether it is a movable asset like machinery, vehicles, or an immovable asset like buildings. The land is considered to be a depreciable asset, though some land does depreciate in value because of erosion or damage to land due to natural forces like earthquake and Tsunami.
TYPES OF DEPRECIATIONS
i. Physical depreciation.
ii. Depreciation due to economic obsolescence.
iii. Depreciation due to functional obsolescence.
iv. Depreciation due to technological obsolescence.
Physical depreciation
This is very common. The physical depreciation occurs due to the usage of the asset. It is the normal wear and tear of the asset. All similar objects do not observe similar depreciation. The Quantum of this depreciation depends on several factors.
i. Manner of usage
ii. Environmental aspect
iii. Natural forces aspects
iv. Accidental Aspects
SOME OF THE IMPORTANT METHODS OF DEPRECIATION
There are several methods of working out the depreciation of an asset. Depending upon the purpose and requirement, the depreciation is based either on historic cost or on replacement cost. Again selection of the method is also based on the purpose and requirement of the user. An accountant may adopt a written down value method of depreciation for buildings and machinery to prepare a financial statement or balance sheet of a company. A valuer wishing to arrive at the market value of the same factory and machinery may adopt the straight-line method of depreciation or the Sinking Fund Method of depreciation.
I. Direct Appraisal Method (Lump sum depreciation).
II. Observed Depreciation Method
III. Written down Value Method, (Accountant’s Method).
IV. Straight Line Method. (More preferred for machinery)
V. Constant Percentage Method. (This linear method is preferred by P.W.D. Engineers).
VI. Sinking Fund Method (This interest-based method is used for buildings).
VII. Sum of the digit method.
VIII. Statutory Depreciation Method
vii. Declining Balance Method. (Accounts method)
The factors that cause depreciation are:
- Wear and tear
- Fall in market value
- Accidents like the fall of a tree
- Obsolescence
- Decay
- Changes in demands
- Changes in Arts and fashion
- Calamity like flood, lightning, etc.
- Actions of elements of Nature like heat, cold, wind, etc.,
- Structural deterioration
Method of calculating depreciation:
The various methods of calculating depreciation are as follows:
- Straight-line Method
- Constant percentage method
- Sinking fund method and
- Quantity survey
In all these methods, it is necessary to decide the economic or effective life of the property.
