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Assignment / Homework Help
Property, plant and equipment used in the business for production or for rendering services are utilized over a period of time, mostly for more than one accounting period. Value of such fixed assets decreases with passage of time and utilization. In order to ascertain correct income, a portion of the cost of fixed assets used in generating revenue must be charged to the revenue. This portion of cost of fixed asset allocated to a particular accounting period is called depreciation.

Depreciation has been defined as the diminution in the utility or value of an asset, due to natural wear and tear, exhaustion, effluxion of time, obsolescence or similar causes. Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected life of the asset.

Depreciation is calculated on all depreciable assets which can be defined as those which have a useful life for more than one accounting period but is limited and are held by an enterprise for use in the production or supply of goods and services.

Objectives of providing depreciation
  • In order to estimate proper income or net profit, depreciation must be charged.
  • Value of the fixed assets must be adjusted for depreciation charged in order to depict the actual financial position.
  • Charge of depreciation enables an enterprise to generate and set aside adequate funds for the replacement of the asset at the end of its useful life.
  • In manufacturing concerns especially, cost of production cannot be accurately determined unless depreciation cost has been considered in the calculations.

Factors to consider in the measurement of depreciation

In order to compute depreciation, the following items or factors are generally considered
  • Cost of the asset
  • Useful life of the asset
  • Estimated scrap value at the end of the useful life

Methods of providing depreciation:

There are several methods of providing depreciation. An enterprise can choose any of the methods for providing depreciation. In some cases, the choice of the method is influenced by the tax benefits and the tax laws of the country. Listed below are the most common methods of providing depreciation.
  • Straight line method
  • Reducing balance method or Declining balance method
  • Double declining balance method
  • Modified Accelerated Cost Recovery System (MACRS) depreciation
  • Sum of years digits method
  • Units of production method

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