Accounting for Fixed Assets
Every business acquires various types of fixed assets such as land & building, plant & machinery, furniture, vehicles etc. These assets are used to derive production capacity. Therefore, they are also known as earning assets. Fixed assets are purchased for continued and long-term use in earning profit in a business. They are written off against profits over their anticipated life by charging an annual amount calculated so as to eliminate the original cost, less scrap, over that period. The life of fixed assets spans over several years. Therefore, the business needs to make long term investment in fixed assets.
Except land, all fixed assets have a limited life. During such period, due to continuous use and/or lapse of time, the value of some assets starts decreasing. Such a gradual decrement of value of assets is called Depreciation. Hence, depreciation can be defined as a decline in the value of an asset due to constant use. Since these assets have limited life, sooner or later they have to be replaced. At the time of replacement, the business incurs heavy cash outflow which can create liquidity problem in that year. In order to avoid such problem, a fixed amount out of profit is set aside as depreciation account. By the time the fixed asset expires, sufficient amount of fund will be accumulated in depreciation account which, then can be used to buy new asset. Hence, the process of setting aside a fixed amount as expense in depreciation account is called Depreciation.
Characteristics of Depreciation
The following are some of the features of depreciation: 1.
Depreciation may be physical and functional. 2.
Depreciation is a gradual/permanent and continuous decrease in the utility value of a fixed asset and it continues till the end of useful life of an asset. 3.
Depreciation arises due to the use of assets in productive activities. 4.
The primary object of depreciation is to allocate expired cost of fixed assets against a number of accounting periods. 5.
Depreciation is charged in respect of fixed assets only i.e., building, machinery, equipment and furniture etc. 6.
Depreciation is a charge against profit. 7.
Total depreciation of an asset can not exceed its depreciable value (cost less scrap value).
Causes of Depreciation
Depreciation is a measure of reduction in the use-value of an asset. It can be physical deterioration or decrease in the market value. The primary causes of depreciation are as follows: 1.
Wear and Tear:
Due to constant use, assets get worn or torn out. 2.
Exhaustion is the depletion of some assets due to continuous use and lapse of time. In case of mines and oil wells, the continuous extraction of minerals or oil, a