Depreciation is the gradual reduction in the value of a fixed asset due to its use, passage of time, wear and tear, or obsolescence.
For example, when a business purchases a machine for ₹1,00,000, the machine will normally lose some of its value every year. This reduction in value is called depreciation.
Depreciation is treated as an expense in accounting and is charged to the Profit & Loss Account.
2. Why is Depreciation Charged?
Depreciation is charged for several important reasons:
Assets lose value because of regular use.
The value of assets decreases with the passage of time.
New technology may make old assets less useful.
It helps calculate the correct profit or loss of a business.
It shows the asset at a more realistic book value.
It helps businesses plan for the future replacement of assets.
3. Which Assets Are Depreciated?
Depreciation is generally charged on fixed tangible assets that have a limited useful life.
Examples include:
Machinery
Furniture
Computers
Vehicles
Buildings
Office equipment
Land is generally not depreciated because it normally has an unlimited useful life, although there can be exceptions depending on the nature of the land.
4. What are the Causes of Depreciation?
The main causes of depreciation are:
Wear and Tear
Assets lose value because of regular use.
Example: A machine used continuously in a factory may become less efficient over time.
Passage of Time
Some assets lose value simply because time passes.
Obsolescence
An asset may become outdated because newer technology is introduced.
Example: An old computer may become less useful when newer and faster computers are available.
Accidental Damage
Damage caused by accidents or natural events may reduce the value of an asset.
5. What are the Main Methods of Depreciation?
The two most commonly studied methods are:
Straight Line Method (SLM)
Written Down Value Method (WDV)
6. What is the Straight Line Method?
Under the Straight Line Method, the same amount of depreciation is charged every year throughout the useful life of the asset.
Formula:
Annual Depreciation = (Cost of Asset − Scrap Value) ÷ Useful Life
Example:
A machine costs ₹1,00,000.
Scrap value = ₹10,000
Useful life = 5 years
Therefore:
Depreciation = (₹1,00,000 − ₹10,000) ÷ 5
= ₹90,000 ÷ 5
= ₹18,000 per year
So, depreciation of ₹18,000 will be charged every year.
7. What is the Written Down Value Method?
Under the Written Down Value Method, depreciation is calculated on the book value of the asset at the beginning of each year.
Therefore, the amount of depreciation generally decreases every year.
Example:
Machine cost = ₹1,00,000
Depreciation rate = 10%
Year 1:
Depreciation = ₹1,00,000 × 10%
= ₹10,000
Book Value = ₹90,000
Year 2:
Depreciation = ₹90,000 × 10%
= ₹9,000
Book Value = ₹81,000
Thus, depreciation decreases as the book value of the asset decreases.
8. What is the Difference Between SLM and WDV?
Basis
Straight Line Method
Written Down Value Method
Depreciation
Same every year
Generally decreases every year
Calculation
Original cost less scrap value
Opening book value
Book Value
Reduces uniformly
Reduces faster in earlier years
Suitable For
Assets providing fairly uniform benefit
Assets that lose value more quickly in earlier years
9. What is the Journal Entry for Depreciation?
The basic journal entry is:
Depreciation A/c Dr. To Asset A/c
This entry records depreciation charged on the asset.
At the end of the accounting period:
Profit & Loss A/c Dr. To Depreciation A/c
This transfers depreciation expense to the Profit & Loss Account.
10. What is the Effect of Depreciation on Profit?
Depreciation is an expense, so it reduces the profit of the business.
For example:
Profit before depreciation = ₹80,000
Depreciation = ₹10,000
Profit after depreciation:
₹80,000 − ₹10,000 = ₹70,000
Therefore, depreciation reduces the reported profit.
11. What is Book Value?
Book Value is the value of an asset shown in the books of accounts after deducting accumulated depreciation.
Formula:
Book Value = Original Cost − Accumulated Depreciation
For example:
Original cost = ₹1,00,000
Accumulated depreciation = ₹30,000
Book value = ₹70,000
12. What is Accumulated Depreciation?
Accumulated Depreciation is the total depreciation charged on an asset from the date it was acquired up to a particular date.
For example:
Year 1 depreciation = ₹10,000 Year 2 depreciation = ₹10,000 Year 3 depreciation = ₹10,000
Accumulated depreciation after 3 years:
₹10,000 + ₹10,000 + ₹10,000 = ₹30,000
13. What is Scrap Value?
Scrap Value, also called residual value, is the estimated amount that a business expects to receive when an asset reaches the end of its useful life and is sold or disposed of.
For example, if a machine costs ₹1,00,000 and is expected to be sold for ₹10,000 after its useful life, ₹10,000 is its estimated scrap value.
14. Why is Depreciation Important in Accounting?
Depreciation is important because it follows the principle of matching expenses with the revenue generated by the asset. Instead of treating the entire cost of a long-term asset as an expense in one year, its cost is allocated over the period in which the asset is used.
This gives a more realistic picture of the business’s profit and financial position.
15. Key Points to Remember
Depreciation = Reduction in the Value of a Fixed Asset
Remember:
Depreciation is an expense.
It reduces the profit of the business.
It reduces the book value of an asset.
Common methods are SLM and WDV.
SLM charges generally equal depreciation each year.
WDV charges depreciation on the opening book value.
Depreciation is generally charged on depreciable fixed assets.
Land is generally not depreciated.
Depreciation helps calculate a more accurate profit and asset value.
Accounting Flow
Purchase of Asset → Use of Asset → Depreciation Charged → Reduced Book Value → Correct Profit Calculation
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