Give the meaning of depreciation. State the causes and methods of depriciation .
Answers
Meaning of Depreciation
The monetary values of all tangible assets tend to reduce gradually over time due to factors like wear and tear. The meaning of depreciation, in very simple words, is the rate at which this value drops. Hence, it compares an asset’s current value with its original cost at the time of acquisition or purchase.
Causes of Depreciation
The most important cause of depreciation is regular wear and tear, but it is certainly not the only one. The following causes can reduce the value of an asset:
Wearing out
Consumption or other loss of value arising from usage
Effluxion of time
Obsolescence through technology
Market changes
There are four common methods of calculating depreciation of assets.
1] Straight Line Method
Straight line method is the simplest way to calculate depreciation. Under this mode, the amount of value reduced from the original cost of the asset remains constant for every accounting year. For example, if we assume the rate of depreciation for a car worth Rs. 10 lakhs to be constant at Rs. 25,000, then its value will reduce by Rs. 25,000 in every accounting year during the course of its useful life.
2] Double-declining balance method
This method of calculating depreciation is based on the presumption that since the productivity of assets falls with time, its rate of depreciation also should be more in the beginning and reduce gradually over time. This method counts the expense incurred by depreciation as twice the book value of the asset for each accounting year.
3] Written down value method
Also known as Diminishing Balance Method. Under this method, the percentage rate of depreciation remains fixed, but we have to reduce the asset’s value during every accounting year. The Income Tax Act, 1961 has prescribed this method for calculation of depreciation.
4] Units of production method
Units of Production Method considers an asset’s productivity and life while computing depreciation, hence, it applies generally to machines, equipment, and vehicles only. Depreciation is based on the total number of units produced or hours put to use by the asset.