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What is depreciation?
Depreciation may be defined as the reduction in the value of an asset with the passage of time. An asset decreases its value with the regular use of an assets. According to the rule of IRS, a business must depreciate their valuable assets.
Depreciation charged on a cost of an asset at the end of each year. Nowadays, each enterprise charge depreciation to avail the tax benefit. Depreciation not only refers to a reduction in the value of an asset but also an accumulation of a fund for future consumption of an asset. It helps the business to maintain its working capital. It is saving for an asset due to the uncertainty of future.
Method of depreciation:
There are two methods of depreciation:
In the case of straight-line method, depreciation charged at a fixed rate on the cost of an asset over its lifetime. In this method, the value of depreciation remains fixed for each year. For example, “A” purchased a machine costing $10000 with the rate of depreciation is 5% for five years. In straight-line method, depreciation will always be 5% of $10000, i.e., $500 each year.
In Written-Down Value method or WDV method, the value depreciation changes every year. In this method, the depreciation is not charged on the cost of an asset. It is charged on the written down value of an asset. As per the above example, depreciation amount will change in this method.
The depreciation amount for 1st year will be $500, but while calculating the amount of depreciation for the 2nd year, it will be charged on the written down value i.e. ($10000-$500) $9500. So the new depreciation amount will be $475.
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Causes of Depreciation: There are some causes of depreciation explained below:
An asset may decrease its value due to the competitive market. The introduction of a new model of machinery decreases the value of the old model, and sometimes it becomes obsolete in the market.
Each and every product has a life of a given period. After using an asset for a period of time, it reduces its working capability, and after the expiry of its life, it becomes obsolete.
An asset can also reduce its value due to regular use of an asset. For example: if you purchase a silver chain and use that regularly, after one year you can check its weight. It won’t be same as before. It is also an example of depreciation.
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