PhD Experts 
Depreciation is one of the most important concepts in accounting and finance, yet many people find it confusing. Whether you run a business, manage accounts, study finance, or simply want to understand how assets lose value over time, knowing what depreciation means can help you make better financial decisions. In simple terms, depreciation refers to the gradual decrease in the value of a tangible asset over its useful life. But this basic definition expands into several methods, rules, formulas, and real-world applications.
This blog will explain what depreciation is, why it is used, how it works, and the different types of depreciation methods all in a clear and beginner-friendly manner.
What Is Depreciation?
Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. When a business buys assets like machines, cars, computers, furniture, or buildings, these items don’t last forever. They wear out, become outdated, or lose efficiency. To reflect this loss of value, businesses charge a portion of the asset’s cost as an expense every year. This yearly expense is called depreciation.
In simple words:
Depreciation spreads the cost of an asset over the number of years it is expected to be useful.
For example, if you buy a computer for ₹60,000 and expect it to last for 3 years, you may record ₹20,000 per year as depreciation.
Why Is Depreciation Important?
Depreciation plays a crucial role in accounting, taxation, and business planning. Here are some reasons why it matters:
a) Shows true financial performance
If a business records the full asset cost in the year of purchase, profit would look unusually low in that year. Depreciation spreads the cost, showing a more realistic profit each year.
b) Helps match cost with revenue
Depreciation follows the matching principle, which states that expenses should match the revenue they help generate. Since assets are used for many years, the cost must be spread accordingly.
c) Useful for tax savings
Businesses can reduce taxable income by claiming depreciation as an expense. This lowers tax liability legally.
d) Helps in asset replacement planning
Depreciation helps estimate when an asset will need replacement. Companies can plan budgets for purchasing new machines or vehicles.
e) Shows actual value of assets
Assets in the balance sheet are shown at their book value—original cost minus accumulated depreciation. This reflects the asset’s current worth.
Key Terms Related to Depreciation
To understand depreciation fully, you must know a few important terms:
1. Cost of Asset
Includes the purchase price plus expenses needed to bring the asset into use (installation, delivery, taxes, etc.).
2. Useful Life
The period for which the asset is expected to generate economic value.
3. Residual or Scrap Value
The amount you expect to get when you dispose of the asset at the end of its useful life.
4. Depreciable Amount
This is:
Depreciable Amount = Cost of Asset − Residual Value
5. Book Value
The value of the asset appearing in the balance sheet after deducting accumulated depreciation.
How Is Depreciation Calculated?
The method used depends on business needs and nature of the asset. Different methods allocate cost differently.
Below are the most widely used depreciation methods.
Types of Depreciation Methods
1. Straight Line Method (SLM)
This is the simplest and most commonly used method.
A fixed amount of depreciation is charged every year.
Formula:
Depreciation per year = (Cost – Residual Value) / Useful Life
Example:
Cost = ₹1,00,000
Residual value = ₹10,000
Useful life = 5 years
Depreciation = ₹18,000 per year
SLM is used for assets like furniture, buildings, and office equipment.
2. Written Down Value Method (WDV) / Reducing Balance Method
Depreciation is charged at a fixed percentage on the reducing book value every year. This means higher depreciation in the early years and lower in later years.
Formula:
Depreciation = Opening Book Value × Rate of Depreciation
This method is common for machinery and vehicles that lose value faster initially.
3. Units of Production Method
Depreciation is based on the asset’s output or usage instead of time.
Formula:
Depreciation per unit = (Cost – Residual Value) / Total Expected Units
Used for production machines, printing presses, mining equipment, etc.
4. Sum-of-Year-Digits Method
A type of accelerated depreciation where more depreciation is charged in early years.
Formula uses:
SYD = n(n + 1) / 2, where n = useful life
This method matches depreciation with asset usage over time.
5. Double Declining Balance Method
Another accelerated method where depreciation rate is double the straight-line rate.
Used in industries where assets lose value rapidly due to technology changes.
6. Depreciation Based on Hours Used
Used for transport vehicles, machines operated in shifts, generators, etc.
Depreciation vs. Amortization vs. Depletion
| Concept | Used For | Nature |
|---|---|---|
| Depreciation | Tangible assets (machines, equipment) | Spread over useful life |
| Amortization | Intangible assets (patents, trademarks) | No physical form |
| Depletion | Natural resources (oil, minerals) | Based on extraction |
Though often confused, these are different accounting treatments.
What Assets Are Depreciated?
Only tangible fixed assets are depreciated. Examples include:
-
Machinery
-
Office equipment
-
Computers
-
Buildings
-
Vehicles
-
Furniture
-
Tools and plant equipment
Not all assets are depreciated. Here are exceptions:
Assets NOT Depreciated
-
Land (does not wear out)
-
Inventory
-
Cash
-
Personal-use items
-
Assets held for sale
Factors Affecting Depreciation
1. Usage
More use usually means faster depreciation.
2. Wear and tear
Machines used in harsh conditions depreciate quicker.
3. Obsolescence
Technology-driven assets lose value faster.
4. Legal or contractual limits
Some assets may have a legal useful life.
5. Market conditions
Price fluctuations may affect asset value.
Adjustments and Special Cases
a) Impairment
If the asset’s value drops suddenly (e.g., damage or technology shift), an impairment loss is recorded.
b) Change in useful life
Businesses may revise useful life based on asset condition.
c) Partial-year depreciation
If an asset is bought mid-year, depreciation is charged only for the months used.
Depreciation in Taxation
Governments allow depreciation as a deductible expense, but tax depreciation rates often differ from accounting rates.
In India, tax depreciation follows the Income Tax Act, where specific rates are prescribed for different assets.
This helps businesses reduce tax liability legally.
Advantages of Depreciation
-
Reduces taxable income
-
Presents realistic asset value
-
Helps in financial analysis
-
Supports budgeting for replacements
-
Allows compliance with accounting standards
Real-World Example of Depreciation
Suppose a business buys a car for deliveries:
-
Cost: ₹6,00,000
-
Residual value: ₹60,000
-
Useful life: 5 years
Using SLM:
Depreciation = (6,00,000 − 60,000) / 5 = ₹1,08,000 per year
This means each year, ₹1,08,000 will be recorded as depreciation expense, reducing profit but accurately reflecting asset usage.
Why Depreciation Matters to Businesses
Understanding depreciation helps businesses:
-
Control finances
-
Compare assets over time
-
Set competitive pricing
-
Understand maintenance vs. replacement decisions
-
Maintain accurate books for audits
Without depreciation, financial statements would be misleading, affecting profitability and planning.
Conclusion
Depreciation is much more than just reducing the value of an asset. It is a systematic accounting process that ensures financial accuracy, helps in tax planning, and supports long-term business decisions. Whether you are a student learning finance, a business owner managing assets, or an accountant preparing financial statements, understanding depreciation is essential.
By allocating asset cost over its useful life, businesses get a clearer picture of expenses, profits, and the actual value of their resources. In today’s competitive world, proper depreciation management can significantly improve financial planning and operational efficiency.
Zener voltage is the specific reverse voltage at which a Zener diode begins to conduct electricity in reverse bias without getting damaged. It is a fixed, stable voltage used for voltage regulation, protection, and maintaining constant output in electronic circuits.
