What is the definition of depreciation in accounting and what is its effect on assets?

We all know that the value of fixed assets owned by any economic entity decreases over time. These are the assets used for more than one accounting year, leading to a decline known as depreciation. Since the decrease in the value of these assets affects their ability to generate income, it also impacts the value of assets on the financial statements. Below, we will explore the details of depreciation and its types in more detail.

What is the definition of depreciation in accounting?

Depreciation is an accounting method used to allocate the costs of tangible assets over their useful life. This allows us to determine the amount of the asset that has been depreciated, helping companies assess the value of their assets over a predetermined period, as well as to calculate the income and revenues that can be generated from those assets.

A clearer definition of depreciation can be presented with an example of expensive equipment and machinery that companies seek to utilize. The costs of these assets are distributed over their lifespan, causing their value to decrease over time. This reduction specifically represents the annual depreciation expense recorded in the company’s accounting books, with the aim of gradually reducing the asset's cost.

Therefore, companies continually consume their assets (such as equipment and machinery) to convert costs into revenues and gains on their balance sheets. Asset purchases are recorded as credit transactions to reduce cash costs, or as accounts receivable to increase asset accounts on the balance sheet.

Causes of Depreciation in Fixed Assets

It is important to note that several factors lead to depreciation in fixed assets, which include the following:

Usage:

Time:

Obsolescence:

External Factors:

Usage: This is the primary reason for depreciation. The more an asset is used, the higher the rate of wear and tear, leading to a decrease in its value. Time: The efficiency and productivity of fixed assets decline over time. As the years pass since their purchase, their value also diminishes. Obsolescence: If assets become outdated and fail to keep pace with technological and scientific advancements, they lose a significant portion of their value and market appeal. External Factors: Certain assets are affected by surrounding conditions, such as natural disasters, climate changes, and accidents, which can damage them and result in a decline in value.

Factors Affecting Depreciation

Land is not considered a depreciable asset because it does not lose value over time. However, several factors influence depreciation, which can be summarized as follows:

Depreciation Method:

Cost of the Fixed Asset:

Useful Life:

Salvage Value:

Depreciation Method: This refers to the approach used to allocate the cost of the fixed asset over its useful life. It varies based on the timing of expense recognition against revenues. Cost of the Fixed Asset: This includes all expenses incurred to acquire the asset and prepare it for use in the production processes within the business. Useful Life: This is the period during which the asset can provide useful services to the business efficiently, measurable in time units, production units, or activity units. Salvage Value: This refers to the estimated value of the asset at the end of its useful life. Salvage value affects the calculation of the depreciable cost by being subtracted from the asset's initial cost.

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