Depreciation is the loss of value of a product over a certain period of time due to wear and tear faced by that particular machinery.
Though speaking on a general note, every company has its own set of provisions to deal with depreciation; there are certain other aspects that need to be taken care of.
Features associated with Depreciation:
Depreciation in value of a product can only be accepted under certain cases where its features match.
- Since depreciation is the loss of the value of assets, hence it should be considered over a certain period of time.
- It can also be stated as the exhaustion of every aspect of a business life. Since, business is primarily associated with value of assets, it is imperative that this value should be of the highest. So depreciation value is to be measured in regards to what a particular machine is able to provide to the company.
- This loss in value is to be measured in a gradual manner.
- What most people do not understand is that, depreciation of assets cannot be equated with maintenance of assets. When assets are maintained, they are simply kept for use in future. As they are not being currently used, hence they do not face any type of wear and tear. Therefore, it can be stated that only when this wear and tear is faced by a particular asset, can it be called depreciation.
- Depreciation can also be stated as allocation of costs of assets to a certain period of its life.
Only when these features match, can it be said that a particular machinery faces depreciation.
Causes associated with Depreciation:
There are certain causes that result in Depreciation.
- With expiry of term, the effective usage of that asset decreases considerably.
- By consistent usage of a product, its quality and productivity reduces comparatively.
- By consistent depletion, which is specifically associated with minerals which once depleted cannot be replenished.
- There are certain abnormal factors as accidents as well that cause this depreciation
- With a permanent fall in price there are chances of high depreciation in value of products.
Factors affecting Depreciation:
There are also lists of factors that affect depreciation in their own respect.
- The approximate useful life of that asset that is being used:
There are multiple factors that are used for determining the life of an asset in terms of its usage, such as its measurement in terms of years, output in terms of unit and finally distance in terms of kilometers.
If expected life usage is high, rate of depreciation is to be low and vice versa.
Points to note:
- Number of shifts for which this mentioned asset is to be used.
- Obsolescence in terms of its technology
- Placement of legal or other restrictions
- Predetermination with set of legal or other contractual basis.
- Repairing of the concerned capital and its maintenance policy.
- Improvement in method of production.
The usage of assets depends on these factors.
- Addition that has been made in terms of assets
Let us take an example in this case. Say, it is taken that a particular machinery is bought on January 1, 2008 for usage at $20,000. An important part of that machinery is added on to that in August 2008 for $5,000. So, when total depreciation would be charged at say 5%, it will be charged on that machinery for a period of 12 months, while on that added part for 5 months only.
- Total cost associated with those assets
To determine rate of depreciation, total cost is taken to calculate the actual amount. This includes, cost of acquiring, installation, as well as construction of assets.
- Legal aspects associated with value of assets
When depreciation amount is calculated, the companies need to take into account legal provisions that are placed in regards to that company.
- Estimated scrap value of the assets
It is this residual value that is to be taken into consideration even when that particular machinery becomes useless or obsolete and there are issues associated with its total price.
Objectives associated with Depreciation:
There are certain specific objectives that depreciation has in regards to a particular company.
- To have a complete knowledge of depreciation helps you get that actual profit and loss amount for your business. Since, to calculate profit or loss is a business one needs to negate that depreciation amount to get the correct value.
- To know the actual amount of depreciation is also important for valuing the actual amount of assets that are there with a particular company.
- It is also important to know the exact value of depreciation since it is based on this that separate provisional funds can be made in regards to assets owned by a company.
- With the depreciation amount collected, it can be stated that the accurate amount of cost that is associated with production is found out. Once this depreciation amount is counted, amount of profit and loss can also be calculated. From that cost of total production can also be calculated.
- There occurs certain times when without calculation of depreciation, total cost incurred on a production may show a higher value. When placed in regards to that, total profits would also show a different value. In this way, there is a high probability that while income tax is calculated, there can be an over-payment of tax.
- Since dividend distribution for shareholders of the company is to be done out of profits earned by a company, it is very important to know what the total amount of depreciation is to ensure that no extra payment harmful for the company is done.
There are other multiple factors that are to be taken into consideration in regards to getting the correct value of depreciation.
Depreciation being a common phenomenon in the business, it is important that it be understood from other points of view as well.
Synonyms for depreciation:
- Depletion:
In case of those firms that deal with raw materials, it is important to note that they have a fixed set of raw materials under their reign. After a certain point of time those materials are reduced due to excess usage. This is known as depletion.
- Amortization:
There are certain intangible services that have a huge role to play in the well-being of a business venture. This is known as amortization.
- Obsolescence:
At times due to technical glitch or even for lack of up gradation, certain machinery have to be thrown away from the factory. To replace this latest machinery have to be bought and this is called obsolescence.
- Fluctuation:
Since assets are bound to face changes in the market, this is known as fluctuation.
Though all these terms add up to the same point of depreciation, however, what matters is their usage in various situations that call for such names.
Links of Previous Main Topic:-
- Book keeping
- Meaning of gaap
- Origin of transaction
- The concept of debit and credit
- Meaning of depreciation
Links of Next Accounting Topics:-
- Depreciation features causes objectives factors
- Fixed or equal installment or straight line method or depreciation on original cost
- Advantages and disadvantages of straight line method
- Diminishing or reducing or written down value method
- Difference between straight line and diminishing balance method
- Depreciation review questions depreciation
