Introduction to Depreciation

The value of an asset, over a period of time, declines due to constant usage and obsolescence. The practice of providing for depreciation spreads the reduction in value of the asset over its useful life.

Significance

Companies use this mechanism to curtail losses when the asset actually stops functioning. Assets whose value decreases with the passage of time are equipment and machinery.

Function

Depreciation ensures that the asset in the company's financial books is always shown at market value and not the purchase value. The market value is the price that the asset would fetch in the market if it were to be sold off.

Time Frame

Depreciation is calculated once annually.

Benefits

There are several benefits of depreciating assets. The company is not affected when the asset stops functioning. The financial statements at all times reflect the true picture of a company's standing. Tax does not need to be paid on depreciation. This money is then distributed to the shareholders as dividends.

Types

There are several methods in which assets could be depreciated. The company should choose the method after taking into consideration the nature of the asset, its usage levels and its estimated useful life. Commonly used methods are the straight line method, sum-of-years method and the double-declining method.

References

• Depreciation
• Depreciation