Definition and explanation of depreciation

Depreciation may be defined as a fall in the value of a fixed asset due to usage, wear and tear, passage of time or obsolescence. The loss is clearly a direct consequence of the services an  asset gives to its owner. It would therefore be quite in order to assume that “the loss in the value of a fixed asset in a period is the worth of  the service provided by that asset over that period”. For example, if a company buys a weighting machine for $1,000 and after a year’s use its value is assessed at $800, it can be said that the service given by this machine in its first year of life was $200 ($1,000 – $800) to the company.

It is in this sense that the depreciation is considered a normal business expense and treated in the books of account in more or less the same way as any other expense.

Fixed assets lose value throughout their useful life, every minute, every hour, every day of it. It would however be impractical and of no great benefit ascertain the extent of this loss in value over short periods like a day, or a weak, or even a month. As business accounts are usually prepared on an annual basis, it is common to calculate depreciation only once at the end of each financial year.

There are three popular methods of calculating depreciation. These are:

  1. Fixed installment method
  2. Reducing installment method
  3. Revaluation method
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