Factors (or) Basis of Providing Depreciation
1. Original Cost of the Asset. Depreciation has to be provided on the original cost of the asset. Cost includes all expenses incurred like freight and installation charges up to the point at which the asset is ready for use.
2. Residual or Scrap Value. The value which an asset brings when it is sold as scrap should be considered before making provision for depreciation. Residual value is an estimated sale value of the asset at the end of its economic life to the business concern.
3. Estimated Working Life. The working life of an asset differs, based on its nature, usage, conditions under which it is maintained and preserved in business. Hence the working life of an asset should be carefully determined to calculate the accurate amount of depreciation.
4. Additions and Extensions. Additions and extensions are made whenever necessary throughout the life of an asset. Such expenditure is capital in nature. When additions are made on an asset, then working life should be extended and depreciation should be provided accordingly.
5. Repairs and Renewals. In order to maintain an asset in good working condition, proper provision for repairs should be provided. By proper maintenance and repairs, the asset works well for the stipulated period otherwise it becomes useless after a few years. This should be considered before providing for depreciation.
6. Obsolescence. Obsolescence is another factor to be considered for depreciation. The innovations and improvements in new technology make the existing asset valueless. Hence, it should be borne in mind before providing depreciation.
7. Interest on Capital Investment. Interest could be earned if the capital involved in purchasing an asset would have been invested elsewhere. The loss of interest on that account should be taken into account before providing for depreciation.
8. Legal Provisions. The provisions of Companies Act and Income Tax Act should be kept in mind before charging depreciation on an asset.