DEPRECIATION OF FIXED ASSETS
Depreciation is the term applied to the permanent reduction in value of a fixed asset and it arises in connection with all fixed assets (except for land) for the following reasons:
| Normal
usage or wear and tear |
| Obsolescence,
caused by a more modern and more efficient machine becoming available |
| Passage
of time. |
Depreciation
is a means of allocating the cost of a fixed asset over its estimated useful
life. The
cost must be spread over the years of the assets useful life and this cost is
charged against the income earned in all accounting periods between the purchase
and the sale of the asset.
Depreciation
is essentially an estimate.
Its assessment is based on several factors which cannot be measured with
any degree of certainty.
To decide on a depreciation policy an Accountant must estimate the
approximate life on the asset and also make allowance for the residual value
(i.e. the amount that will be received when the asset is eventually disposed
of.
It
should be decided as to whether the loss should be shared evenly in each year,
or whether in some years the asset is used more than others.
As such there are two main depreciation methods:
| Fixed
Instalment Method.
Depreciation is calculated at a fixed rate on the cost price of the
asset. |
| Diminishing
Value Method.
Depreciation is based on the book or written down value (which is the
original cost less all accumulated depreciation to date).
One of the advantages of this method is that it automatically makes
allowance for residual vale, as the amount of depreciation becomes smaller
each year and the asset is never completely written off. |
Assets
are recorded in the Balance Sheet at their written down value.
It is wrong to regard balance sheet figures for fixed assets as
representing their realisable value, as this may not be the case.
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