Depreciation Accounting Concept

 

Depreciation Accounting Concept (PART-I)

Depreciation Accounting Concept followed by the many businesses to maintain their Capital Goods Account. This account is very necessary for a business to ascertain the actual value of the machinery at the end of the financial year.  

Depreciation Meaning: According to AICPA, “Depreciation Accounting is a system of accounting which aims to distribute cost or the basic value of tangible capital assets less salvage value (if any), over the estimated useful life of the unit in a systematic and rational manner.

According to R.N. Carter, “Depreciation is a gradual and permanent decrease in the value of an asset from any cause.”

Characteristic of Depreciation

•      It is mainly charged on fixed assets.
•      It is charged against profit. So, it is chargeable even at the stage of loss.
•      The amount of depreciation will not vary for fluctuation.
•      It is an internal transaction and it has no outside effects.
•      It is not the internal source of capital of the concern.
•      It helps to maintain the physical capital of the concern at the end of each accounting period. 

The Types of Depreciation may be discussed below

Internal Causes: The causes of depreciation related to the assets i.e. internal activities of the concern, which call the internal causes of the depreciation.

Wear & Tear: Land and Buildings, Plant and Machinery, Furniture and Fixture etc. damage for their uses and reduced their values, efficiencies, and utilities.

 Physical Consumption: As a result of excavation of minerals from mines, collection of wood from forest etc. the natural wealth reduce for physical consumption.

External Causes: The causes of depreciation that are not related to the assets of the business call external causes of depreciation.

Efflux of Time: Leasehold Property, patent rights, copyrights, etc. are decreasing their value, utilities and effectiveness on passage of time. At the end of life, these values become Zero.

Obsolescence: The plants, machinery, and other fixed assets that are to be substitute more powerful and effective machines in the modern world and effective machinery become useless due to time, i.e. the value of assets will decrease. If any fixed assets may be useless due to an accident. The loss due to obsolescence considers as depreciation.

Permanent Fall in Market Price: The value of assets which depends on the market price, decreased if the market price falls e.g. shares, bonds, debentures etc.

Accident: The assets of concern may demand natural calamities as, earth-quick, fire, flood, and riots. Then the full value of lost assets writes off as depreciation.

Decay: Certain fixed assets are losing their services, qualities or strengths by the effects of nature such as moisture, sunlight, storms etc. The decay considers as depreciation.

Inadequacy: Due to the development of modern technology and productions procedure, the old and used fixed assets can not meet the production needs. So, new and better assets should replace in place of old assets. The loss due to inadequacy considers as depreciation.  

Objective of Depreciation

There is the following objective of depreciation discuss below:

To find out the real profit or loss: The depreciation on fixed assets charge to Profit & Loss Account. if the depreciation on fixed assets is not charged in a profit and loss account of the accounting period.

To find out the correct value of assets: At the end of each accounting period, if depreciation on fixed assets is not charged to the profit and loss account. The correct value of fixed assets is not to find out. So, the provision for depreciation is necessary to find out the correct value of assets at the end of each accounting period.

To find out the real cost of production: The depreciation on Plant & Machinery, Furniture & Fixture, Land & Building etc. Which use in production, is a part of factory overhead. If the depreciation is not charged on the assets, i.e. It does not include the cost of production; the real cost of production cannot ascertain. So, it is necessary to find out the real cost of production.

To replace the assets: The fixed assets are useless in the passage of time and a huge amount of money is necessary to replace the assets at a time. If depreciation is charged against profit, a portion of the profit is retained in the business in form of depreciation.

To maintain the financial capital: The financial capital is reduced for the purchase of assets. The recovery of that financial capital from income is essential. If the amount of financial capital is not recovered from the profit, it is distributed to related persons from the business. So, the creation of provision for depreciation is necessary for a business to maintain the financial capital intact.

To ascertain Profit or Loss on sale of assets:  Any fixed assets may be sold at the end of effective life or based on the requirement. The profit or loss on sales of assets is ascertained by the differentiating between written down value and sale value of the related assets. But the written down value cannot be ascertained if depreciation is not changed.

To avoid over payment of income tax: If depreciation is not charged in the profit and loss account, the amount of profit will increase. As a result, income tax is to be paid for more profit. To avoid over payment of income tax reasonable depreciation is to be charged in the Profit & Loss account.

To abide by the legal restrictions: Under Section 205 of the Companies Act,1956. Dividends cannot be distributed among the shareholders before charging depreciation on fixed assets. So, the charging of depreciation is essential to abide by the legal restrictions.