What Is Depreciation ?
Depreciation refers to the reduction in the fair value of fixed assets (such as buildings, machinery, vehicles etc.) over time due to passage of time, wear, tear etc. In accounting it is considered as non-cash expense that affects the tax and profitability of the firm.
Key Features Of Depreciation
Major characteristics or features of depreciation can be listed as follows:
1. Relation With Fixed Assets
Depreciation is related to fixed assets such as buildings and machinery except land. It is not applicable for intangible assets such patent, copyright etc.
2. Fall In The Value
It is continuous fall or decrease in the value of assets. It means book value of the asset continuously decreases over useful life.
3. Causes
There are several causes of depreciation. It may arises due to wear and tear, depletion, obsolescence, inadequacy, effluxion of time, accidents , regular use, passage of time, perishability, poor upkeep etc.
4. Continuous Process
Depreciation is a continuous and gradual process of decrease in the value of assets till the useful life. Every year the amount of depreciation is subtracted from the book value of the fixed property.
5. Charge Against Profit
True profit of the business is ascertained after deducting depreciation expenses from operational profit. Therefore, it impacts the profitability of the business.
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6. Non-cash Expense
Depreciation is a non-cash expenditure because it is not a part of actual cash flow like salaries, bills payment etc. So, it does not impact the cash flow of the firm.
7. Tax Purpose
Taxable profit of the firm is determined by deducting depreciation expenses from the operating profit. So, it minimizes the tax liability of the company.
8. Multiple Methods
There are multiple methods such as straight line method, reducing balance method and units of production method to calculate the amount of depreciation.
9. Impact On Financial Statements
Depreciation impacts the financial statement such as income statement, balance sheet and cash flow statement of the firm.
10. True Value
Depreciation helps to reveal true book value of the physical assets that eliminates overstating of their value.