The Causes of Depreciation

Depreciation occurs because of decline in the usefulness of the asset. The causes for the decline in the usefulness of the asset may be divided into two categories; namely (a) Physical and (b) Functional.
The Physical deterioration (decline) of an asset may arise due to wear and tear and passage of time.

Wear and Tear from use:

It is a common knowledge that most fixed assets suffer from wear and tear in use which ultimately renders an asset unusable in course of time. Parts are worn down by friction or they break. There may be other damage such as corrosion.

Passage of time:

Many long terms assets lose their usefulness with the passage of time simply because they are older – whether they are being used or not. For example machines may rust. Similarly, the structure of building comprising of walls, roofs, flooring etc. is subject to automatic decay due to action of weather elements (e.g. rainfall, heavy storms) and limit effect of the materials used for constructing it. Therefore depreciation must be provided for building.
 
The functional factors limiting the life of fixed assets are: (i) inadequacy and (ii) obsolescence.

Inadequacy:

A fixed asset becomes inadequate. If its capacity is not sufficient to meet the demands increased production. It can no longer meet production schedules and requires replacement. Although the asset is still usable, its inadequacy for present purpose has cut short its services life. The reason for the inadequacy may be traced to change in the nature of the business – method of manufacture, type of product of design – which makes necessary the disposition of the assets or their replacement. Changed economic conditions may also become functional causes of depreciation such as when an old airport terminal building becomes inadequate and must be abandoned and a new larger one is built to meet the requirements of heavier traffic. It is a kind of intramural (within the business) obsolescence.

Obsolescence:

The most important functional or non-physical cause is obsolescence which means the reduction of utility of an asset that result from the development of a better machine or process. There may not be any physical deterioration in the asset itself. The obsolescence may occur due to technical and economic reasons. The technical obsolescence arises directly when a new and improved model of a machine reduces the unit cost of production to the point where continued operation of the old machine is not economical or suitable for further use. The economic reasons of obsolescence relate to products or services which a particular asset produces or renders. Such products or services may have lost their market demand or it may not be worthwhile to use an asset at all, say, in the case of a railway line which is specifically laid to a particular factory or mine, and on permanent closure of such factory or mine, the railway line which is physically as good as ever would not be having any use at all. Thus new inventions, changes in manufacturing methods (automation), shifts in demand for products or services or any other condition make the asset out of date.

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