DEPRECIATION

DEPRECIATION

Depreciation can be defined as the gradual reduction in the value of a fixed asset as a result of wear and tear, passage of time and obsolescence.

TERMINOLOGIES

1. Depreciable Asset: This is an asset which has the following qualities
2. Useful life of over one years
3. Acquired primarily for use in production of goods and services
4. Limited useful life
5. Not intended for sale in the ordinary course of the business
6. Residual Value: This is also known as the scrap value. It is the estimated amount recoverable from the disposal of a fixed asset after its expected  useful economic life.
7. Depreciable Value: This refers to the net book value of a depreciable asset that could be allocated to future operations through depreciation.
8. Useful Life: The estimated number of years through which an asset can be cost.

The causes of depreciation may be classified into physical deterioration, economic factors, time factors and depletion.

1. Physical Deterioration 
2. Wear and Tear: This is physical deterioration or loss of value suffered by a fixed asset as a result of usage.
3. Erosion, rust, rot and decay: These are physical deterioration or loss of value suffered by fixed assets as a result of exposure to wind, sun, rain and other elements of nature

 

Economic Factor:

1.  Obsolescence: This is the process of becoming obsolete or out-of-date. It is the loss of value suffered by a fixed asset as a result of advancement in technology. E.g. Black and white TV as a result of development of colour TV, Nokia 3310 as a result of Java phones, coal engine as a result of diesel engine.
2.       Inadequacy: This is the loss of value suffered by an asset as a result of growth and changes in size of a firm. E.g. computers with less capacity will be inadequate to a larger firm.

In both inadequacy and obsolescence the asset may not necessary be scrapped but may be used by other smaller firm who may need them.

3. Time Factor: although the other causes of depreciation may be connected to time, there are fixed assets whose values are specially connected to time. These are assets with fixed period of legal life such as leases, patents, copyright. Instead of using the term depreciation, the term amortization is often used for the provision for the consumption of these assets.
4. Depletion: This is the loss of value suffered by assets of wasting nature as a result of exploitation. Examples include natural resources such as mines, quarries, oil wells and forest reserve.

To provide for the consumption of assets of wasting nature is called provision for depletion.