Meaning and Definition of Depreciation on Fixed Assets
Depreciation means the fall or decrease in the value of assets.Depreciation is the permanent decrease in the value of depreciable assets while used in the course of business. Land, forest, goodwill, cattle, and R&D are not depreciable assets. Depreciation is not apparent, unlike other corporate costs, which are visible and taken into account when calculating profit/loss. However, this is not the case with asset depreciation. Its amount is also not fixed.
It is based on past experience. Some business owners do not account for asset depreciation and do not remove gross profit from net profit. One thing to remember is that depreciation is determined on fixed assets. And it is deducted from the profit to determine the net profit. Of course, present assets may lose value. Current asset value losses are computed on the basis of cost or market price, whichever is smaller. Valuation of current asset is done for the purpose of balance sheet only.
Generally there is depreciation in all fixed assets due to some reasons. There are a few cases in which the values of the assets appreciate as land, antiques and old paintings, etc. As per Accounting Standard-6 the depreciable assets are those which:
1. Are expected to be used during more than one accounting period, and
2. Have a limited useful life, and
3. Are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.
Definitions
In the AS-6 the depreciation is defined as, “Depreciation is a measure of wearing out, consumption or other loss of value of a depreciable asset, arising from use, affluxion of time or obsolescence through technology and market changes. Depreciation is allocated so as to change a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset".
Depreciation includes amortisation of assets whose useful life is predetermined.” As per International Accounting Standards Committees, “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 or indirectly”.
According to J.H. Burton, “Depreciation is the shrinkage in the value of an asset at a given date as compared with its value at a previous date”. From the above definition it is clear that depreciation is gradual fall in the value of the assets due to some reasons.
Significance of Depreciation
Depreciation is provided in the books from the following point of view:
1. To present the assets at its true value in balance sheet: Depreciation is computed on the fixed assets. In the balance sheet, it is represented against fixed assets. As a result, the balance sheet presents the genuine and fair picture of the company's financial status. We Notes would be wrong if we did not make a provision for depreciation for fixed assets, and the balance sheet would not reflect the real worth of assets.
2. To ascertain the correct profits or losses: The true profit can be ascertained only after deducting the all costs from the revenue of a period. Because the assets are employed to generate income in the firm. The value of assets decreases as a result of such corporate use. As a result, such a decrease in value should be viewed as a cost and deducted from profit. Payment for the purchase of assets should be viewed as anticipated costs and spread out over time to determine the genuine profit.
3. To create a fund for the replacement of assets: If the depreciation on fixed assets is provided and charged against the profit every year, there will be reduction in the profit by the amount of depreciation. If the amount is transferred into a fund account, on the expiry of the life of the machine, there will be creation of depreciation fund to replace the fixed assets.
