REASONS AND AIMS OF DEPRECIATION - Accounts and Finance for Managers

Reasons for Depreciation

  1. Wear and Tear of the Asset: The long term assets are becoming less efficient and poor quality in operations due to the continuous usage of the asset.
  2. Exhaustion: Nothing will be remaining due to the continuous extraction of resources. The resources in the oil wells, mine fields will become nothing due to continuous extraction should be replaced by new exploration. To invest on the new exploration in order to have continuous exploration which requires the depreciation as a charge against the revenues of the fields.
    Example, Oil & Natural Gas Corporation Ltd. (ONGC) indulges in the process of new oil exploration projects through research projects. Then the new projects should be identified and invested by huge initial investment outlay through the current revenues out of the existing projects on account of replacement due to depletion of resources..
  3. To Face Technological Obsolescence: To replace the old machinery with new machinery before the expiry of the economic life period of the asset in order to maintain the efficiency and economy of the asset. The type writer was replaced by the electronic typewriter during the yester periods of office automation. To replace the old type writer which is not efficient as well as economical, should be replaced by the new electronic typewriter through the depreciation charge on the old one.
  4. Accident: The value of the asset mainly depends upon the efficiency and economy; which gets affected due to the accident.

Aims and Objectives of Depreciation

Aims of Charging Depreciation

  • To recover the cost: The depreciation charge is a mean to recover the cost of operations of the enterprise. More specifically to recover the cost of asset procured which is in usage.
  • To facilitate the induction of new asset: To replace the old one, the new asset has to be purchased only with the help of depreciation charge
  • To find out the correct P&L accounting balance
  • To know the original position of the enterprise through proper adjustments on the fixed assets

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