Causes of Depreciation
Depreciation refers to the continuous decline in the book value of fixed assets. It does not occur because of any one specific reason but it is a combination of various factors that work together which eventually lead to depreciation.
Depreciation occurs due to normal wear and tear, regular consumption, passage of time or obsolescence of technology. These are some of the major causes of depreciation. It is charged every year to the Profit and Loss account so that cost of asset is equally divided over the years.
A detailed explanation of causes of depreciation is given under –
1. Wear and Tear due to Use
When an asset is used for the business operations regularly, it is exposed to consequent deterioration leading to gradual decline in the value. It happens because the asset becomes less efficient with every use as its technical capacity reduces.
2. Wear and Tear due to Passage of Time
The value of an asset not just declines because of continuous usage, it is also affected by the time factor. Even if the asset is not being put to any use, it will still be subject to depreciation. This takes place especially when the assets are exposed to the rigours of nature like weather, winds, rains, etc.
3. Expiration of Legal Rights
Some assets can be used for business operations only for a fixed period of time. This time period is predetermined by the government or any other authority. These assets lose their value at the end of the expiry period. Examples of such assets are – patents, trademarks, copyright, leases etc. They are valid till they are backed legally.
Obsolescence means being “out-of-date”. With improvement in technology, a better quality asset replaces the existing assets every now and then. The emergence of newer and more efficient assets make the older ones outdated. This poses the need to depreciate the asset as it has become less valuable. It occurs due to these factors:
- Better technological changes;
- Improvements in production methods;
- Change in tastes of customer causing a fluctuation in market demand for the product;
- Legal factors or other descriptions.
5. Abnormal Factors
There are certain factors which do not cause continuous or gradual decline in the value of assets. Such factors are known as abnormal factors. For eg – fire outbreak, earthquakes or any other natural calamity. These cause a permanent diminution in the value of fixed assets and therefore need to be accounted as and when they occur.
The causes of depreciation are quite a few. Some lead to a continuous decline in value while others affect the asset permanently. They need to be taken into account so as to record the assets at their true value, otherwise it will lead to overstatement of figures.