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Karnataka class 12 commerce Accountancy Causes for depreciation

Karnataka class 12 commerce Accountancy Causes for depreciation:

Karnataka class 12 commerce Accountancy Causes for depreciation: Depreciation may be described as a permanent, continuing and gradual shrinkage in the book value of fixed assets. It is based on the cost of assets consumed in a business and not on its market value. 

Karnataka class 12 commerce Accountancy Causes for depreciation:

Karnataka class 12 commerce Accountancy Causes for depreciation

Karnataka class 12 commerce Accountancy Causes for depreciation:

Causes of Depreciation –

These have been very clearly spelt out as part of the definition of depreciation in the Accounting Standard 6 and are being elaborated here.

Karnataka class 12 commerce Accountancy Causes for depreciation:Wear and Tear due to Use or Passage of Time -Wear and tear means deterioration, and the consequent diminution in an assets value, arising from its use in business operations for earning revenue. It reduces the asset’s technical capacities to serve the purpose for, which it has been meant. Another aspect of wear and tear is the physical deterioration. An asset deteriorates simply with the passage of time, even though they are not being put to any use. This happens especially when the assets are exposed to the rigours of nature like weather, winds, rains, etc.

Karnataka class 12 commerce Accountancy Causes for depreciation: Expiration of Legal Rights –Certain categories of assets lose their value after the agreement governing their use in business comes to an end after the expiry of pre-determined period. Examples of such assets are patents, copyrights, leases, etc. whose utility to business is extinguished immediately upon the removal of legal backing to them.

Karnataka class 12 commerce Accountancy Causes for depreciation: Obsolescence  Obsolescence is another factor leading to depreciation of fixed assets. In ordinary language, obsolescence means the fact of being “out-of-date”. Obsolescence implies to an existing asset becoming out-of-date on account of the availability of better type of asset. It arises from such factors as:

  • Technological changes;
  • Improvements in production methods;
  • Change in market demand for the product or service output of the asset;
  • Legal or other description.

Karnataka class 12 commerce Accountancy Causes for depreciation: Abnormal Factors- Decline in the usefulness of the asset may be caused by abnormal factors such as accidents due to fire, earthquake, floods, etc. Accidental loss is permanent but not continuing or gradual. For example, a car which has been repaired after an accident will not fetch the same price in the market even if it has not been used.

Need for Depreciation The need for providing depreciation in accounting records arises from conceptual, legal, and practical business consideration. These considerations provide depreciation a particular significance as a business expense.

Matching of Costs and Revenue The rationale of the acquisition of fixed assets in business operations is that these are used in the earning of revenue. Every asset is bound to undergo some wear and tear, and hence lose value, once it is put to use in business. Therefore, depreciation is as much the cost as any other expense incurred in the normal course of business like salary, carriage, postage and stationary, etc. It is a charge against the revenue of the corresponding period and must be deducted before arriving at net profit according to ‘Generally Accepted Accounting Principles’.

Consideration of Tax Depreciation is a deductible cost for tax purposes. However, tax rules for the calculation of depreciation amount need not necessarily be similar to current business practices,

True and Fair Financial Position If depreciation on assets is not provided for, then the assets will be over valued and the balance sheet will not depict the correct financial position of the business. Also, this is not permitted either by established accounting practices or by specific provisions of law.

Compliance with Law Apart from tax regulations, there are certain specific legislation that indirectly compel some business organisations like corporate enterprises to provide depreciation on fixed assets.

Karnataka class 12 commerce Accountancy Causes for depreciation:

Matching principle requires that the revenue of a given period is matched against the expenses for the same period. This ensures ascertainment of the correct amount of profit or loss. If some cost is incurred whose benefit extend to more than one accounting period, it is not justified to charge the entire cost as expense in the year in which it is incurred. In fact, such a cost must be spread over the periods in which it provides benefits. Depreciation, on fixed assets, which is the main subject matter of the present chapter, deals with such a situation. Further, it may not always be possible to ascertain with certainty the amount of some particular expense. Recall the principle of conservatism (prudence) which requires that instead of ignoring such items of costs, adequate provision must be made and charged against profits of the current period. Moreover, a part of profit may be retained in the business in the form of reserves to provide for growth, expansion or meeting certain specific needs of the business in future. This chapter deals with two distinct topics and hence is being presented in two different sections. First section deals with depreciation and second section deals with provisions and reserves.

Karnataka class 12 commerce Accountancy Causes for depreciation:

Depreciation – Now you are aware that fixed assets are the assets which are used in business for more than one accounting year. Fixed assets (technically referred to as “depreciable assets”) tend to reduce their value once they are put to use. In general, the term “Depreciation” means decline in the value of a fixed assets due to use, passage of time or obsolescence. In other words, if a business enterprise procures a machine and uses it in production process then the value of machine declines with its usage. Even if the machine is not used in production process, we can not expect it to realise the same sales price due to the passage of time or arrival of a new model (obsolescence). It implies that fixed assets are subject to decline in value and this decline is technically referred to as depreciation. As an accounting term, depreciation is that part of the cost of a fixed asset which has expired on account of its usage and/or lapse of time. Hence, depreciation is an expired cost or expense, charged against the revenue of a given accounting period. For example, a machine is purchased for Rs.1,00,000 on April 01, 2014. The useful life of the machine is estimated to be 10 years. It implies that the machine can be used in the production process for next 10 years till March 31, 2015. You know that by its very nature, Rs. 1,00,000 is a capital expenditure during the year 2014-15. However, when income statement (Statement of Profit and Loss) is prepared, the entire amount of Rs.1,00,000 can not be charged against the revenue for the year 2014-15, because of the reason that the capital expenditure amounting to Rs.1,00,000 is expected to derive benefits (or revenue) for 10 years and not one year. Therefore, it is logical to charge only a part of the total cost say Rs.10,000 (one tenth of Rs. 1,00,000) against the revenue for the year 2014-15. This part represents the expired cost or loss in the value of machine on account of its use or passage of time and is referred to as ‘Depreciation’. The amount of depreciation, being a charge against profit, is debited to Income Statement (Statement of Profit and Loss).

Karnataka class 12 commerce Accountancy Causes for depreciation:

  • Karnataka class 12 commerce Accountancy CH1 DEPRECIATION PROVISIONS AND RESERVES
  • Karnataka class 12 commerce Accountancy Features of depreciation

Karnataka class 12 commerce Accountancy Causes for depreciation:

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