It is the loss of value of a non-current asset throughout its period of use by the firm. IAS 16 on property, plant and equipment defines depreciation as the allocation of a depreciable amount of a non-current asset over its estimated useful life. Under the matching concept, all incomes or revenues and expenses for a particular period should be reported in the financial statements and because depreciation is an expense of the business therefore, it will be charged in the profit and loss account.
Causes of Depreciation
1. Physical Factors
- Wear and tear: Some non-current assets depreciate or lose value due to use overtime e.g. machinery and motor vehicles.
- Rot/decay/rust: This happens on assets that are not well maintained by the firm e.g. some machines.
2. Economic Factors
- Inadequacy: Some assets lose value due to them becoming inadequate e.g. when a business grows or expands then some buildings may become inadequate due to space. Also some machines are unable to manufacture a large number of goods.
- Obsolescence: Some assets become obsolete due to change in technology or different methods of production e.g. computers.
3. Time Factors
Some assets have a legal fixed time e.g. properties on lease.
4. Depletion
This occurs when some assets have a wasting character due to extraction of raw materials, minerals or oil. Such assets include mines, oil wells, and quarries.