Depreciation refers to the decrease in the value of an asset due to factors such as its usage, wear and tear, accidental damage, and the passage of time leading to obsolescence.
The extent of depreciation an asset experiences is determined by three main factors:
The significance of these factors can vary depending on the type of asset and how intensively it is employed. Depreciation can be allocated uniformly over the entire useful life of an asset, or it can be weighted more heavily towards the initial years of an asset's life. The amount of depreciation should reflect the reduction in the asset's value over time. If all purchased items were completely used up by the end of the year of their acquisition, calculating depreciation would not be necessary. However, items like buildings, equipment, and livestock are gradually consumed over many years, raising the question of how to determine their cost for a specific accounting year.
There are two perspectives on an asset's lifespan. In developing economies, assets remain in use as long as they can be maintained. In developed countries, new and improved assets, particularly more efficient and cost-effective machines, are constantly introduced, leading to the replacement of assets even before they reach their full working life. In such cases, the "time" depreciation, known as obsolescence, is as significant as "use" depreciation. When considering an asset's working life, it is important to seek input from past experience, insights from neighboring farmers, and opinions from experts like engineers. Factors such as the likelihood of obsolescence and the asset's residual or scrap value should also be carefully taken into account. At the end of its useful life, the asset's value may be entirely depleted or reduced to its scrap value.
(a) Depreciation Computation: Depreciation charges essentially serve as a way to apportion the cost of assets over their period of utilization. When calculating depreciation, both aspects of depreciation, namely, usage and time, should be taken into account. There are three approaches to determining annual depreciation, as outlined below:
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