Causes of Depreciation
Depreciation is the value reduction in the carrying amount of the fixed asset (or property plant & equipment) from period to period which is charged in the statement of profit & loss of organization for the same period to provide the reasonable cost of the asset which has been used during that period. Common causes of depreciation include wear and tear due to usage, compliance to accounting standards, technological advancements etc.
The reduction in the carrying amount of fixed assets over the period of its useful life is due to many reasons. Some of them are as follows:
Top 7 Causes for Depreciation
#1 – Due to Wear & Tear during Usage of Asset
It is one of the primary reasons for the depreciation of assets. Most of the assets are worn off or get deteriorated due to the continuous usage of the asset. Such as Plant & Machinery used for the production of goods, buildings, vehicles, etc. As in the case of machinery used for production, the continuous usage & running of machinery the working or production capacity of the machinery diminishes over the period of time & the value of the machinery also decreases in the market. So for the fair presentation of the financial position of the entity, it is necessary to reduce the proportionate value of the machinery in the books.
#2 – Compliance of Accounting Standards Applicable to Entity
As per the applicability of accounting standards on the entity, the entity needs to follow the provisions mentioned in the standards. It is done as per the matching concept that needs to be followed on the accounting of the entity. As per the matching concept, the depreciation is to be charged for the respective as the income through the asset has also been booked for the period mentioned above in the books of accounts.
#3 – Technological Advancement of Supplementary Assets in Market
The value of the fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. used by the enterprise gradually decreases in the market in case the new upgraded version of the asset with the better technological advanced features is present in the market, providing more benefits to the customer in comparison to the old obsolete version of the asset. In such a case, the requirement of the old asset gradually decreases, so does its recoverable amountRecoverable AmountThe recoverable amount of an asset is the present value of the expected cash flows that will result from the asset's sale or use, and is determined as the greater of two amounts: the asset's fair value as reduced by related selling costs, and the asset's value in use. in the market. Hence it is necessary to show the value of the asset at a fair amount or reasonable amount in the financials.
#4 – Use of Provided Life of Asset
In some of the cases of fixed assets, the useful life of the assets is provided in consumption units like an asset ‘X’ will run for 10000 hours. Hence the allocation of the cost of the asset is as per the consumption or its usage in hours.
#5 – Amortization of Assets as per License Period or Usage Period
Some of the assets like license, patent, copyrights, leasehold properties, etc. can only be used for the provided period of time. At the lapse of such time, the asset could not be used. Hence its cost needs to be allocated or amortized as per the usage period of the assets. At the end of the useful period, assets should be written off from the books of accounts.
#6 – Depreciation Needs to be Done for Wasting Assets as per Extraction of Resources
In case of wasting assetsWasting AssetsWasting assets refer to fixed assets or financial instruments that have a short life or lose their value over time. Fixed assets like equipment, furniture or vehicle and the financial market instruments such as options belong to this category. like coalmine, well of oils, etc. are amortized and used as per the extraction of natural resources done from them during the period. In the case of such types of wasting assets, there are limited resources that an entity can extract from such assets for the use of the organization. As per the estimated total extraction that will be done from the wasting asset and amount already extracted, during the respective period will be considered for the depreciation of the asset during that period.
#7 – The Absolute Need for Maintenance of Fixed Assets for Proper Productivity of Asset
The plant & machinery used in the manufacturing of products in a manufacturing company needs regular maintenance over some time for full-time productivity to be received from the usage of such machinery. Even after a certain period, some essential parts of the machinery are to be replaced with brand new parts. For such, the depreciation needs to be charged so that the parts that are to be replaced in the future are appropriately accounted for and written off during the period of its life.
The depreciation and amortization are allowed by the companies act or the statutory laws. It applies to the entity for writing off the used part or cost of the asset in the statement of profit & loss account of the entity for the period mentioned above as per the matching principle in accounting. There are many causes or reasons for doing such treatment. This matching concept provides a fair presentation of the financials of an entity as the cash inflow generated from the asset has been booked, and the respective usage cost of the asset is also written off during the same period as per the matching concept in accounting. The income tax laws, as well as statutory laws (including accounting standards), mandate the treatment and chargeability of depreciation in the books of accounts for the respective period.
This article has been a guide to Causes of Depreciation. Here we discuss what Depreciation is, and significant causes of depreciation include Due to Wear & Tear during Usage of Asset, Use of Provided Life of Asset, etc. You may learn more about financing from the following articles –