Accountancy: Depreciation: Characteristics, Causes and Journal Entries (For CBSE, ICSE, IAS, NET, NRA 2022)

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  • Depreciation is the loss arises in the value of fixed tangible asset due to wear and tear and passage of time. Fixed assets have a long life and are held for use in the business for production of goods and services. Whenever an asset is used in business its value gets reduced and sooner or later the asset becomes useless. Depreciation is a permanent, continuous and gradual shrinkage in the book value of a fixed asset. It is the fall in the quality or value of a fixed asset through physical wear and tear due to use or passage of time or from any other cause. Depreciation takes place irrespective of regular repairs and maintenance. As the asset is used for business purpose, the annual loss in the value of the asset is like any other expenditure. Hence, the cost of fixed assets has to be written off over its useful economic life as a loss.
  • The Institute of Charted Accountants of India (ICAI) has defined depreciation as ″ a measure of the wearing out, consumption or other loss of value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes.

Characteristics of Depreciation

  • Depreciation refers to a permanent, continuous and gradual decrease in the utility value of a fixed asset and it continues till the end of the useful life of the asset.
  • Depreciation is a charge against profit (i.e.. revenue earned) for a particular accounting period.
  • Depreciation is always computed in a systematic and rational manner since it is not a sudden loss.
  • Depreciation is a process of allocation of expired cost and not of valuation of fixed assets.
  • Whatever method for calculating depreciation is followed, the exact amount of depreciation can never be calculated, and it can only be estimated.
  • Depreciation is caused due to physical factors and functional factors.
  • The fundamental objectives of depreciation are - (a) to maintain the nominal capital invested in fixed assets, and (b) to allocate the expired portion of the cost of fixed assets over a number of accounting periods.
  • Depreciation is must, i.e.. it always takes place whether the asset is carefully handled or neglected.
  • If the market value of a fixed asset is fluctuating, the same does not affect the amount of depreciation so made on the respective assets.
  • Depreciation is calculated in respect of fixed assets only, i.e.. plant, machinery, furniture etc.
  • Total depreciation cannot exceed its depreciable value or original cost where the scrap value is nil.

Causes of Depreciation

  • Physical wear and tear
  • Physical deterioration
  • Depletion of wasting assets
  • Obsolescence etc.
Causes of Depreciation

Journal Entries of Depreciation

Depreciation Account Dr.

To Asset Account

Methods of Depreciation

Straight Line Method

Under this method, a fixed proportion of the original cost of the asset (less residual value) is written off each year so that asset account may be reduced to its residual value at the end of its estimated economic useful life. It is assumed that depreciation is a function of time. Depreciation is charged on a uniform basis every year till the asset is written off.

Straight Line Method

Diminishing Balance Method

Under this method, depreciation is calculated at a certain percentage each year on the balance of the asset which is brought forward from the previous year. The amount of depreciation charged for each period is not fixed but it goes on decreasing gradually as the opening balance of the asset in each year will reduce. Thus, amount of depreciation becomes higher at in the earlier periods and becomes gradually lower in subsequent periods, while repairs and maintenance charges increase gradually.

Diminishing Balance Method

Difference between Straight Line Method and Diminishing Method

Difference between Straight Line Method and Diminishing Method
Straight MethodDiminishing Method
It is calculated based on the original cost of the asset.It is calculated based on the written down value of the asset in the subsequent year.
The depreciation amount remains same for all the years.The amount goes on reducing from year after year.
It is easy to calculate the rate of depreciationIt requires use of mathematical tables.
It is suitable where repair charges are less .It is suited where repair charges are more in later years.

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