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Chapter: 12th Auditing : Chapter 7 : Depreciation

Causes for Depreciation

The causes of depreciation can be classified as – (1) Internal causes, and (2) External causes.

Causes For Depreciation

The causes of depreciation can be classified as – (1) Internal causes, and (2) External causes.


 



INTERNAL CAUSES

Wear and tear, exhaustion, depletion, deterioration etc., causes depreciation on assets which are internal in nature.


1. Wear and Tear: The value of capital assets like plant, machinery, building etc. decrease in value due to constant use. The wear and tear of an asset depends on the usage of asset. For example, when machinery is used for three shifts the wear and tear will be greater than the machinery which is used on a single shift. The difference between the value of an asset when it was purchased and its value after being used for some time period represents wear and tear of the asset.

2. Exhaustion: Certain assets like plantations and livestock loose their value with lapse of time as they are being used or consumed. These assets have a definite period of life after which they exhaust in value and become useless.

3. Depletion: Natural resources such as mines, quarries and oil wells are of a wasting character and are called as wasting asset. These assets loose their value due to extraction of oil, depletion of minerals and metals. Thus, the value of wasting assets declines due to gradual exhaustion.

4. Deterioration: Deterioration means erosion in value of those assets which have a very short period of life. The fall in value of those assets refers to depreciation.

 

EXTERNAL CAUSES

External factors which cause depreciation include passage of time, obsolescence, permanent fall in market value and due to weather and accidental calamities. These factors are not connected to the inherent nature of the asset.


1. Effluxion or Passage of Time: The utility of some fixed assets like patents, copyrights, trademarks, leasehold property etc. is confined to a time frame. The value of the asset decreases after a particular period of time. For example, asset like lease hold property becomes valueless after the expiry of the period of lease.

2. Obsolescence: The value of an asset decreases due to – (a) inventions of new and improved techniques or production methods, for example, old machines become out dated with the introduction of new machines, (b) decline in market due to change in taste and fashions, or change in market conditions, for example, the demand for a product or service falls to such a level that it is no longer viable to continue with that product or service, (d) legal restraints, etc. These factors make it economical to replace the assets though they are still usable.

3. Due to Weather and Natural Calamities: Some assets lose in value when they are constantly exposed to rain, sun, wind etc. and certain assets decline in value when they are affected by certain natural calamities like flood, earth quake, fire etc.

4. Permanent fall in the Market Value: Assets like investments lose in value due to permanent fall in market value of the asset. Such a fall in the price of an asset should be treated as depreciation. Temporary fall in the value of investments should be ignored for calculating depreciation.

 

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