by Michael Nnopu

Created on: July 20, 2010

Understanding depreciation is quite simple when you appreciate the reason behind its usage. Businesses acquire assets that are not meant for resale in the ordinary course of business, but are meant to be used over and over again in the production of other goods and services. For such assets, it is not proper to write off their historical cost from the books of accounts as expenses when they are bought, as this contravenes the

matching concept in accounting. The proper accounting treatment of such assets is to spread their value over their estimated life span or write off their value from the books over their life span. This spreading of value over time is called Depreciation.

Understanding depreciation cannot be possible without a proper definition. Technically, depreciation can be defined as the systematic and periodic allocation of the historical cost or revalue amount less estimated residual value of a depreciable asset over its estimated useful life. It can also be defined as the gradual fall in the value of a fixed asset due to wear and tear, passage of time, and obsolescence. Although it is pertinent to point out that not all assets that are used in the production of other goods and services are depreciable. Examples of such assets are land and building. These two might actually appreciate in value rather than depreciate.

Reasons for Depreciation

Several reasons have been advocated why depreciation is charged as expenses in the books of accounts, these include:

Wear and Tear of the assets over time occasioned by repeated use. Assets that are employed in the production process normally get damaged or breakdown over time. Even when repaired and serviced, the fact still remains that there has been a reduction in value.

Passage of time is also another factor affecting the value of assets. Even for assets that are not employed in the production process, but are exposed to the elements. Vehicles parked under the elements are typical examples. After being under the sun, rain and dew for years, even when not in use, they are not expected to maintain their original value.

Obsolescence meaning out of fashion or old fashion will also affect value of assets. Examples of such are abound in the ICT industry. Products produced and parked long ago, will not find it easy to attract buyers today, reason being that better models are now in the market.

In accounting, there are several methods of treating depreciable assets; these include: straight line method, reducing balance method, sum-of-the-years digit method, and the revaluation method. Understanding depreciation methods properly equips the accountant to make the right decision, as different assets require different treatments. Whatever method adopted, it is important to be consistent in its use in line with Generally Accepted Accounting Principles (GAAP).

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