Causes-Of-Depreciation Igcse Edexcel

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Exam code:4AC1

Introduction to depreciation

Depreciation is applied to non-current assets to represent the reduction in their value
Depreciation is the financial measure of how the value of an asset decreases over time
Depreciation is an expense that accounts for the estimated loss in value of an asset during a given period
- It is an expense that does not involve spending money
It is used to spread the cost of the assets over their expected useful life
You need to know two methods to calculate depreciation
- Straight line method
- Reducing balance method
The accounting concept of consistency states that when a business chooses a method of depreciation for a type of non-current asset, it must use that method each year unless there is a valid reason to change to a different method
- Different methods can be used for different types of non-current assets

Depreciation is used so that the business adheres to the following accounting concepts:
Accruals
- The capital expenditure of a non-current asset is matched against the income that it has contributed to
  - Suppose that a business buys a vehicle for $30 000 and expects it to be useful for 8 years
  - The full $30 000 should not be charged as an expense straightaway
  - Instead, the expense should be spread out over the 8 years that it is contributing to income
Prudence
- The value of the assets should not be overstated
- Depreciation allows the business to report a more realistic estimation for the valuation of its assets

Different businesses will have different policies for dealing with depreciation for the year in which the asset is purchased and the year in which the asset is sold or disposed of
The business could:
- Charge a full year’s worth of depreciation
- Charge no depreciation
- Charge a proportion of the full year’s worth of depreciation
The exam question will specify which rules should be used

The value of a non-current asset depreciates due to:
- Wear and tear of the asset
- The asset becoming outdated or obsolete
- The reduction in the expected useful lifetime of the asset
- The asset being used up or depleted

Cause	Explanation
Wear and tear	The non-current asset might deteriorate which causes it to be less useful. This could be due to excessive use or physical deterioration such as rust. For example, a vehicle might have scratches which lowers its value.
Obsolescence	The non-current asset might lose value as technology advances. The non-current might become inadequate for the growing needs of the business. For example, a computer might become obsolete when a newer model is released.
Passage of time	The non-current asset might have a fixed number of years. For example, a vehicle might be leased for five years.
Depletion	The non-current asset might be used up so that there is nothing left. For example, the business might have natural resources such as oil which will eventually be used up.