Depreciation

Definition of depreciation

Is that part of the original cost of a non-current asset that is consumed during its period of use by the business, OR Is the fall in value of an asset.

Causes of depreciation

Physical deterioration

1. Wear and tear.
2. Erosion, rust and decay.

Economic factors

1. Obsolescence.
2. Inadequacy.
3. Time.
4. Depletion.

Physical depreciation

These are the natural wear and tear effects on an asset due to its use and environmental factors over time.

1. Wear and Tear:
   • As assets are used, they gradually lose value due to the physical exertion and stress they endure.
   • This is typical for machinery, equipment, vehicles, and other assets that experience regular use and movement.
2. Erosion, Rust, and Decay:
   • Over time, certain assets like buildings or machinery exposed to the elements can undergo erosion or rust.
   • Materials like metal may rust due to exposure to moisture, and wooden structures may decay or deteriorate due to weather conditions, leading to a decrease in value.

Economic factors

These are external and internal factors that contribute to the decline in an asset's value, irrespective of its physical condition.

1. Obsolescence:
   • Assets may become obsolete when new technologies, processes, or products replace them.
   • For instance, computers and machinery can become outdated due to advancements in technology, rendering older models less valuable even though they might still be physically operational.
2. Inadequacy:
   • This occurs when an asset becomes insufficient or unsuitable for its intended purpose, typically due to changes in business operations or requirements.
   • For example, an expanding business may find that its old machinery is no longer capable of handling the increased production demands, leading to a decrease in the asset's usefulness.
3. Time:
   • The passage of time causes depreciation because, as time passes, assets generally lose their value, regardless of how much they are used.
   • Some assets, like buildings or furniture, may still be functional but experience wear due to the mere passage of time, leading to depreciation.
4. Depletion:
   • Depletion applies primarily to natural resources (e.g., minerals, oil, timber, etc.).
   • It refers to the gradual consumption or extraction of a natural resource, reducing its value over time. The asset is depleted as the resource is harvested or extracted.