Meaning of Depreciation

The primary meaning of the word ‘depreciation’ is the reduction in or loss of quality or value of a fixed asset through physical wear and tear in use or passage of time or from any other cause. In this sense the term depreciation describes a fact and therefore depreciation must take place whether it is shown in the books of account or not. Machines wear out, leases come to an end and these and other similar things are therefore said to depreciate because they do not last for ever. Deprecation does take place irrespective of regular repair and efficient maintenance. Thus, the fact that an asset is maintained by incurring substantial expenditure on repairs does not put the depreciation to a bought. A possible exceptions is sometimes made in respect of the value of land which has indefinite or unlimited useful life and its cost has tended to increase everywhere in the world. Land in some other forms of use such as mine or quarry will also reduce in value. It is very important to make it clear that fall in value associated with depreciation is necessarily a fall in book value. It cannot be market value since in some cases there may be in fact in increase in the market value. It cannot be the cost price because the depreciation has no direct relation to cost and is not necessarily calculated as a certain percentage of the cost. Depreciation is charged not a basis of cost, but in accordance with a schedule previously drawn up at the time the asset is first put into use. The cost appears in calculations only indirectly and nominally in as much as the cost price is one of the two factors which give us the total amount of depreciation. Depreciation, therefore, refers to a fall in the book value which may or may not be equal to the market value of the asset or cost price except in the first year of the life of the asset. Book Value is a presumed value which is determined arbitrarily on the basis of the method of depreciation used. The fall in the book value of the asset has the following features:

(i)    The fall in the book value is of permanent nature. When depreciation is charged, the book value is reduced and it is not possible to restore it to its original cost;

(ii)    The fall in book value is a continuing process because the book value is reduced either with the use of the asset or over passage of time (i.e., deterioration in value)

(iii)    The fall in book value takes place gradually unless there is a quick physical deterioration or, obsolescence due to technological developments. The terms depreciation is used only with reference to tangible fixed assets because the permanent, continuing and gradual fall in book value is possible only in the case of tangible fixed assets and these characteristics of fall in the book value are non-existent in the case of wasting and intangible assets. In fact, other terms are used for the depreciation of wasting assets and intangible assets such a depletion of natural resources and amortization of goodwill respectively.

Depletion:

This is used in relation to natural resources or wasting assets such as mines, oil wells, timber, trees, etc. As the resources is extracted or removed, its asset value will be reduced or exhausted. The reduction in value or expiration of cost of asset resulting from production is called depletion.

Amortization:

This term is used in respect of intangible assets like patents, copyright, leaseholds and goodwill which are recorded at cost. Some intangible assets have a limited useful life and are, therefore, written off. The process of their writing off is called amortization
The A.I.C.P.A states: “Depreciation can be distinguished from other terms with specialized meanings used by accountants to describe assets costs allocation procedures. Depreciation is concerned with charging the cost allocation procedures. Depreciation is concerned with charging the cost of man-made fixed assets to operation. Depletion refers to cost allocation for natural resources such as oil mineral deposits. Amortization relates to cost allocation for intangible assets such as patents and leaseholds. The use of the term depreciation should be avoided in connection with the valuation procedures for securities and inventories.”

For more help in Meaning of Depreciation click the button below to submit your homework assignment