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Depreciation Accounting

(Accounting Concept of Deprecation)

The accounting concept of depreciation means that depreciation is a process of allocation not of valuation. Depreciation accounting is a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage value, over the estimated useful life of the unit in a systematic and rational manner. It is a process of allocation not of valuation. Accounting for depreciation as allocation of cost is necessitated by the fact that certain tangible fixed assets such as plant, machinery, building, furniture and the like are capable of generating revenues over a number of accounting, periods since these assets in effect constitute the bundle of services. It becomes necessary to spread the cost of fixed assets over the accounting periods during which part of their services potential is used up. It is this process of spreading cost over a number of accounting periods that is called depreciation accounting. The important point to be noted that the depreciation in accounting is neither the recording of physical deterioration nor recording the decline in the market value of machine or any other fixed asset. The purpose of depreciation is to recognize the expiration of asset cost through use. Its primary purpose is cost allocation. The main emphasis in depreciation accounting in on the calculation of the amount of depreciation as periodic charge to be allocated as an expense to be matched with revenues reported in each accounting period. Depreciation treats the original cost of the asset as deferred expenses and the original cost of the asset is therefore charges against the income of various accounting periods by allocation is over its useful life in a systematic manner. In accounting, depreciation does not refer to physical deterioration of an asset or decrease in market value of an asset overtime. Accounting for depreciation is simply the allocation of cost of a tangible fixed asset to the accounting periods that benefit from the use of the said asset. In brief, the following points may be emphasized to explain the depreciation accounting:

(i)    Depreciation accounting is the process of allocation the cost of the tangible fixed asset less its salvage value over its serviceable life. It means the depreciation charge calculated for accounting purpose has no connection either with the rate of physical deterioration or decay of the asset or with the decline in the market value of asset. In fact as asset may show little physical decline in the early years and may have significant physical utility at the time of retirement.

(ii)    Deprecation is an expense that is to be charged against the revenue whether the business enterprise makes profit or incurs loss; the amount to be allocated each year is based on some rational mathematical system in advance so that each accounting period that benefits from the asset’s use bears its fair share of the asset’s cost. Depreciation expense is not affected by the changes in the level of repairs or maintenance to keep the fixed assets in excellent condition.

(iii)    Depreciation does not provide funds are replacing the asset when its useful life ends. It simply writes off the cost of an asset, already incurred as an expense. The amount of ‘accumulated depreciation’ shown in the balance sheet is not the amount of funds being saved by the firm to replace the asset at the end of its life; it simply provides information about the extent to which the asset has been depreciated.

(iv)    Depreciation accounting does not refer to the decline in the value of current assets such as marketable securities or inventories resulting from obsolescence of spoilage. It is also not used as a charge for wasting assets or intangible assets.

(v)    Land is not subject to depreciation because its useful life is considered to be unlimited except where land is used as a site and the value may decline due to socio-political factors.

(vi)    Depreciation is not a process of valuation. The valuation concept consideration depreciation as the decline in the value of the asset over a period of time. It is related to the balance sheet which reflects the values of various assets over a period of time. The value of an asset may be: (i) market value or (ii) value to the owner. The valuation concept would provide a very satisfactory basis for distributing depreciation charge for different year of assets in use. Decline in value of an asset is not uniform and would make the income comparison, difficult and unreliable. Even if the market value of an asset increases, depreciation has to be recorded because of allocation process.

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