Diminishing Value & Depreciation
Companies provide for depreciation on their plants and equipment. This is necessary, as the value of assets falls due to the passage of time, constant usage and obsolescence. There are several tools for depreciation. The diminishing value depreciation method is one in which an asset's value is written off more during its initial years than its later life.
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Features
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This method of depreciation is an accelerated depreciation method. It works on the premise that the assets are on their productive bests during their initial life span. Hence, they have more value to lose during this period. The asset is depreciated every year as per its book value at the beginning of the year.
Function
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By depreciating the asset, the company is able to ward off losses when the asset actually stops working. By following the diminishing balance method, the company has already written off a majority of the reduction in the asset's value, hence it does not become too much of a problem to buy a new asset.
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Benefits
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Provision for depreciation is not taxable. Therefore, the management is either able to distribute the saved money as dividends to the shareholders, or retain it in the business for expansion.
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