Depreciation

Depreciation — The Core Idea

When a business buys a fixed asset — a machine, a building, furniture, a vehicle — that asset is not consumed in one year. It gives service for several accounting periods. But with every year of use, the asset loses some of its value. Even if it sits idle, time alone reduces what it could be sold for. And sometimes a newer, better model makes the old one less valuable. This gradual, permanent decline in the value of a fixed asset is called depreciation.

Depreciation is not a guess or an optional adjustment. It is an expense — a real cost of running the business. The logic is simple: if an asset costs ₹1,00,000 and will work for 10 years, it is unfair to charge the whole ₹1,00,000 against the revenue of just the first year. Only the part of the cost that has been "used up" in that year should be treated as an expense. That used-up part is depreciation.

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The Textbook's Example — Step by Step

A machine is purchased on April 1, 2017 for ₹1,00,000. Its useful life is estimated at 10 years (it will serve till March 31, 2027).

• The entire ₹1,00,000 is a capital expenditure in the year 2017-18.
• But the machine will generate revenue for 10 years, not just one.
• So only one-tenth of the cost — ₹10,000 — is charged as depreciation for 2017-18.
• This ₹10,000 is the expired cost for that year, debited to the Statement of Profit and Loss.

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Definition of Depreciation (as an Accounting Term)

It is an expense — charged against the revenue of the accounting period in which it is incurred.

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Causes of Depreciation

The textbook identifies three fundamental causes:

1. Use — The more an asset is used, the faster it wears out. A machine running two shifts depreciates faster than one running one shift.
2. Passage of time — Even if an asset is not used at all, its value falls simply because time passes. Legal rights (like a patent or lease) have a fixed life; physical assets rust or become outdated.
3. Obsolescence — A newer, more efficient model arrives. The old asset, though still physically functional, becomes less valuable because it is no longer the best way to do the job.

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Why Depreciation is Charged — The Need

The textbook makes clear that depreciation is not optional. It is needed because:

• The cost of a fixed asset must be spread over the periods that benefit from it (matching principle).
• Charging only a part of the cost each year gives a truer picture of profit.
• If the full cost were charged in the purchase year, profit would be understated that year and overstated in later years.

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Distinction from Amortisation and Depletion

The textbook introduces these related terms but does not elaborate in this section. The key distinction is:

All three are the same idea — gradual write-off of a long-lived asset's cost — but the textbook uses different names for different types of assets.

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Accounting Treatment of Depreciation

The textbook states clearly:

The amount of depreciation, being a charge against profit, is debited to Income Statement (Statement of Profit and Loss).

The journal entry is:

Then, at the end of the period, the Depreciation account is closed by transferring it to the Statement of Profit and Loss: