Maharashtra Board Class 11 Book Keeping and Accountancy Chapter 7 Depreciation PDF Download

Depreciation

Meaning And Definition Of Depreciation

In daily life, we use many assets which could be Tangible or Intangible. Such assets have their own life e.g. Building, Furniture, Machinery, etc. It is necessary to spread the cost over a number of years during the useful life of the assets. This process of spreading the cost of fixed assets is termed as 'Depreciation'.

The word depreciation is derived from the Latin word 'Depretium' which means reduction.

Every business concern acquires some fixed assets which are used in the business for its trading activity. These assets are purchased for business with an intention of permanent use and not for resale.

Working life of all fixed assets, except Land, decreases with the passage of time. The value of these assets decrease every year. So reduction in the value of fixed assets due to its Wear and Tear or actual use is called as 'Depreciation'.

"Depreciation is defined as shrinkage in the value of an asset due to wear and tear, passage of time or obsolescence."

Unless depreciation is charged to the revenues, the true income of the business cannot be ascertained properly, and we cannot make provision for their replacement. Purchase of an asset is a capital expenditure and not a recurring expenditure.

Teacher's Note

Depreciation means the value of your things goes down over time. Like when you buy a new bicycle for ₹5000 and after 2 years it becomes old, its value becomes ₹3000. This loss of value is depreciation.

Exam Trick

Remember: Depreciation = value goes down. Just like your school uniform becomes old and less valuable after wearing it for many days, business assets also become less valuable every year.

Points to Remember

Depreciation is the loss in value of a fixed asset every year.
It is charged on all fixed assets except Land.
Depreciation is a non-cash expense.
It helps to find the true profit or loss of the business.
We must charge depreciation even when the business is making losses.

Note

Land is never deprecated, many a times it is appreciated. Moreover, the area of the Land neither increases nor decreases.

Depreciation is charged every year whether the business concern is earning profit or suffering a loss.

Definition

1. "Depreciation is the gradual decrease in the value of an asset from any cause." - R.N. Carter

2. "Depreciation may be defined as a gradual deterioration in the value due to use." - R.G. Williams

3. "Depreciation may be defined as permanent and continuing diminution in the quality, quantity or the value of an asset." - William Pickles

4. "A measure of the wearing out, consumption or other loss of a value of a depreciable asset arising from use, effluxion of time or obsolescence through technology and market changes." - The Institute of Chartered Accountants of India (ICAI)

5. "Depreciation is the allocation of the depreciable amount of an asset over its estimated useful life. Depreciation for the accounting period is charged to income either directly of indirectly." - The International Accounting Standard Committee (ICAC)

6. "Continuous, gradual and permanent reduction in the value of assets is called depreciation."

Causes Of Depreciation

Depreciation happens for many reasons. Let me tell you what causes it.

1. Normal and Natural Wear and Tear - Value of fixed asset is reduced due to its normal and natural wear and tear or actual use. More the use of an asset, more the wear and tear.

2. Passage of Time - Fixed assets get depreciated due to affluxion of time, so it is necessary to depreciate them even if they are not in use. e.g. Patents, Trademarks, Copyrights, Leases, Software, Designs, etc.

3. Obsolescence - On account of technological development or changes in techniques of production, the old assets become obsolete or out-dated and all these cause reduction in their values. It is called obsolescence. e.g. Computer, Television, etc.

4. Depletion - To deplete means to empty. Depletion is also one of the causes of decrease in the value of wasting assets such as Forests, Oil-wells, Mines, Quarries, etc.

5. Natural Calamities/Impairment of an Asset - The price of fixed assets decreases due to natural calamities such as earthquakes, storms, cyclones, fire, floods, or accidents, etc. and damages of the assets is accounted for in the Books of Accounts.

6. Invention - When the new machines or assets are invented, the earlier assets or machines being used may lose their utility and hence their value is reduced. e.g. When in the market, i-phone 8 was introduced the value of i-phone 7 reduced.

7. Market Value - Market Value of an asset goes on changing according to the prevailing conditions. Hence depreciation also changes. When market value of an asset decreases as compared to its cost, it causes the depreciation on it.

Teacher's Note

Depreciation happens because things get old and used. When your parents buy a car for ₹10 lakh, after 5 years it is worth only ₹6 lakh because it is old and used.

Exam Trick

Remember: All fixed assets except land lose value every year. Think of it like your school books - they become old and less valuable each year you use them.

Points to Remember

Wear and tear from using an asset causes depreciation.
Time passing also causes depreciation even if you do not use the asset.
New inventions make old assets lose value quickly.
Natural disasters can cause sudden loss in asset value.
Market conditions affect the value of assets.

Need And Importance Of Depreciation

1. Depreciation is charged to Profit and Loss A/c as it is an element of Cost. It is also essential to arrive at true value of the asset and also net Profit or Loss during a particular accounting period. Even if an asset is not in use, its value is reduced due to passage of time. Depreciation is Cost/Loss to the business. It is a non-cash expenditure. It is a Nominal Account.

2. If depreciation is not provided and deducted from the value of assets, the assets will be overvalued and we cannot find out true and fair financial position of the business.

3. Depreciation is necessary to make provision for replacement of old assets. If provision for depreciation is not made, the business may not have sufficient funds to replace them.

4. It enables the business to compute and pay correct amount of tax to the Government.

5. Depreciation must be calculated and equivalent funds should be provided for every year, so that at the end of its life, the assets may be easily replaced.

Teacher's Note

Depreciation helps businesses know the real profit they made. If a company buys a machine for ₹1 lakh and does not show it got old, the profit will look too high and not real.

Exam Trick

Remember: Depreciation shows the true picture. Like in your school accounts, if you have old furniture but still show it as new, the real value is wrong. Depreciation fixes this.

Points to Remember

Depreciation helps find the true profit or loss of the business.
It provides funds for buying new assets when old ones wear out.
It shows the real value of assets in the Balance Sheet.
Depreciation helps pay correct tax to the Government.
Even unused assets must be depreciated because time passes.

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