The Accounting Concept of Depreciation

The accounting concept of depreciation

According to the A.I.C.P.A., depreciation accounting is 'a system of accounting which aims to distribute the cost. . . of tangible capital assets, less salvage (if any), over the estimated useful life of the unit . . . in a systematic and rational manner. It is a process of allocation, not of valuation'. (A.I.C.P.A., 2018.)

From the foregoing definition of depreciation accounting, two important points may be made:

(a) Depreciation accounting is not concerned with attempting to measure\ the value of an asset at any point of time. One is trying to measure the value) of the benefit the asset has provided during a given accounting period, and that benefit is valued as a portion of the cost of the asset. Hence, the balance sheet value of depreciable assets is that portion of the original cost which has not yet been allocated as a periodic expense in the process of income measurement. It does not purport to represent the current value of those assets.

(b) Depreciation accounting does not itself provide funds for the replacement of depreciable assets, but the charging of depreciation ensures the maintenance intact of the original money capital of the entity. Indeed, a provision for depreciation is not identified with cash or any specific asset or assets.

Depreciable and non-depreciable fixed assets The most common types of fixed assets are:

(a) Land and buildings

(b) Plant and machinery

(c) Furniture and fittings

(d) Motor vehicles

(e) Tools and sundry equipment.

The essential difference in the accounting treatment of fixed assets is to be found in the distinction made between depreciable and non-depreciable assets. Generally, land and buildings are not depreciated: on the contrary, they are sometimes revalued from a historical cost basis. Other fixed assets such as plant and machinery, furniture and fittings, motor vehicles, tools and sundry equipment are depreciated, although, exceptionally, tools and sundry equipment are placed on a revaluation basis or a replacement basis as a means of calculating the amount to be charged as a periodic expense. It may be said, therefore, that the distinction between depreciable and non-depreciable fixed assets rests on the susceptibility of an asset to physical deterioration or obsolescence. Thus, commercial buildings such as shops and offices are not generally depreciated, but industrial buildings normally are.

Factors in the measurement of depredation

There are four factors which are important in the process of measuring depreciation from an accounting viewpoint, as follows:

(a) identifying the cost of the asset

(b) ascertaining its useful life

(c) determining the expected residual value

(d) selecting an appropriate method of depreciation which must be systematic and rational.

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Read on: Depreciation As a Fall in Value

Depreciation as a fall in value

There are some problems associated with the use of the term 'value' and the relationship of depreciation to the concept of value. Value may mean 'cost value' 'exchange value', 'use value' (utility) or 'esteem value'. Clearly, 'cost value' is not affected by events occurring after acquisition, so that it is not meaningful to relate depreciation to a fall in cost value. 'Exchange value' changes only twice in the experience of the owner of an asset-at the point of purchase and at the point of sale. In this sense, depreciation may mean only a fall in price between two... see: Depreciation As a Fall in Value