Obsolescence

Obsolescence is a factor that causes a fixed asset to lose value even when it is still physically in good working condition. The word itself means becoming "out-of-date." An asset becomes obsolete not because it has worn out, but because a better, more efficient, or more suitable asset has become available.

This loss of usefulness is driven by external changes, not by the asset's own use or the passage of time. The textbook identifies four main causes of obsolescence:

• Technological changes: A new machine is invented that can produce the same goods faster, with higher quality, or at a lower cost. The old machine, though functional, is no longer economical to use.
• Improvements in production methods: A new manufacturing process is developed that makes the existing asset's role unnecessary or inefficient.
• Change in market demand for the product or service output of the asset: The product that the asset was bought to make is no longer in demand. For example, a machine that makes DVD players becomes obsolete when the market shifts to streaming services.
• Legal or other restrictions: A new law or regulation may ban the use of a certain type of asset (for example, an old, polluting boiler) or make its output illegal to sell.

The accounting treatment for obsolescence is identical to that for any other cause of depreciation. The loss in value is recorded by debiting the Depreciation Account and crediting the Asset Account. The Depreciation Account is then closed by transferring its balance to the Profit and Loss Account (or the Profit and Loss Appropriation Account in the case of a partnership firm). The journal entry is: