Depreciation Definition - Meaning And Explanation

Depreciation Definition And Meaning

What is Depreciation?

Depreciation is the Systematic allocation of the cost of the Fixed Assets / Non Current Assets over its useful life. With the passage of time, the market value of Fixed Assets / Non Current Assets may increase or decrease, but for proper allocation of the assets, deprecation is calculated by applying different Depreciation Methods in order to estimate the usefulness of the assets within the estimated useful life.

Note: The term "Depreciation" is used when allocate cost of an Tangible Non Current Asset while the word "Amortization" is used when we allocate cost of an Intangible Non Current Asset.

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Explanation

1. It is to be noted that valuation of assets is different than allocation of the cost of the assets in the sense that valuation is the process of finding the market value of the asset for selling in the marketplace while allocation of the cost of the assets is the process of finding the usefulness of the assets used in the business within the useful life. For Example, the value of building may decrease or increase within in the useful life of the business. If the useful life of the building expires but still the market value of the building is increasing or more than previous years of purchase, then, in this case, the asset is revalued to find out its useful life again for using the business.

2. Fixed Assets / Non Current Assets become Obsolete due to wear & tear and usage. Also due to improved technology, these become ineffective e.g., due to the improved technology of office equipment, old equipment needs to be replaced to perform better and meed market demands.

3. Depreciation is an expense account in the Current Accounting Period.

4. Is Accumulated Depreciation An Asset or a Liability or An Expense?

Accumulated Deprecation is a Contra-Asset Account which is the total of deprecation already allocated to expense account in the previous Accounting Period within the useful life of assets. The Closing Balance of Accumulate Depreciation is Deducted From Relevant Fixed Assets / Non Current Assets on the Balance Sheet.

5. Fixed Assets are recorded on the Balance Sheet at Historical Cost or Written Down Value / Carrying Value (Cost - Accumulated Depreciation).

6. Depreciation Journal Entry

When depreciation is allocated to expense for the first time from the date of purchase of the Fixed Assets (Plant & Machinery), then following Accounting Journal Entry is passed in the book of the business:

           Depreciation Expense  a/c XXX

                                       Accumulated Deprecation - Plant & Machinery a/c XXX

(Depreciation on Plant & Machinery is allocated to expense account)

Depreciation for the Current Accounting Period is recorded in Depreciation Expense Account and Accumulated Depreciation - Plant & Machinery Closing Balance is transferred to Balance Sheet to deduct it from Plant & Machinery.

So, we can say that deprecation is the proper allocation of the cost of the Fixed Asset / Non-Current Asset used in the business within its useful life and it is different from valuation of assets.