Over a period of time, all the things that we use become old. We humans too grow old. Our productivity is reduced then. This is true even for the machinery, buildings cars, and all assets. These too become old, obsolete or worn out. You cannot sell an old car which has visited the mechanic umpteen times at a high price. This decrease in the value of assets has to be recorded for accounting purpose. Hence the concept of depreciation came into existence.
Practically fixed assets do not give huge returns like Qprofit system. Click here now to know how. In business, it is inevitable to invest in machinery and building which depreciate. Please find the below uses of depreciation:
- Depreciation ensures that the fixed assets of a business are shown in the books at their present values. This will ensure that firms do not overrate their assets and build their balance sheets.
- Depreciation can be claimed as an expense. Few nations allow tax rebates on them.
- The reduction in asset value has to be accounted gradually over years. A sudden reduction in value will impact the business profit. Depreciation enables gradual reduction over years.
Types of depreciation:
Following are the different types of depreciation:
- Straight line method: This is the simplest form of depreciation. The amount of depreciation remains the same for each year. The amount is arrived by dividing the cost of the asset less salvage value by Number of years for which the asset can be used.
- Double declining method: The same percentage of depreciation is reduced from the opening book value of the asset every year.
- Units of production method: It is based on the total hourly usage of the asset and the total number of units produced using the asset.
- Sum or years method: One of the accelerated methods of depreciation is the sum of years method. In this method, a higher rate of depreciation is claimed during the initial years. A lower rate is charged during the subsequent years.
Maintaining the assets in excellent condition will reduce their wear and tear. This will also fetch a good salvage value. Sometimes firms create provision by creating a depreciation fund. An equivalent amount will be allocated to the fund every year. Finally, this fund will be used for replacing the worn-out asset with a new one. The concept of a fund is a very useful and innovative idea. It removes the worries of raising fund for asset replacement.