The causes of depreciation can be stated as follows:

1.Wear and Tear: Wearing out of the asset on account of its constant use is called wear and tear. This causes a definite reduction in the value of the asset and is regarded as the Major source of depreciation.

2.Lapse of Time: Normally, the passage of time also causes some reduction in the value of fixed assets because as they become old their value stands reduced. That is why the depreciation is usually charged on time basis. In case of certain assets like least., patents, etc., the ,value decreases with passage of time as they generally have a fixed number of years of legal life. For example, a building is taken on lease for a period of 10 years costing Rs. 100000. The yearly depreciation of lease will amount to Rs. 10,000 (1/10 of Rs. 100000) and charged as such to the Profit and Loss Account every year.

3.Obsolescence: The acquisition of an improved model may render the existing machine obsolete. As the new machine performs the same operation more quickly and/or more economically existing machine is said to have become out of date or obsolete. This causes a drastic reduction in the value of existing machinery and the amount of depreciation is bound to be heavy.

4.Depletion: Some assets are of a wasting character. For example mines, quarries, oil wells etc. Due to continuous extraction of materials the natural resources get depleted. Depreciation, in case of such assets is often computed on the basis of actual depletion. For example, a coal mime has the coal deposits of 200 million tons. In the first year we extract 10m tons of coal. The depreciation in the first five years shall amount to 10/200 of the cost of mine.

On the basis of the causes mentioned above, it can be said that depreciation is a permanent and continuous reduction in the value of an asset due to wear and tear, passage of time, obsolescence, depletion or any other cause.

You know depreciation is treated as a loss and is chargeable to the Profit and Loss Account every year. The justification for charging depreciation can be explained as follows:

1.Ascertaining the true profits: Depreciation represents the expired cost of a fixed asset caused by its usage in business. This cost is a part of the total expenses incurred in earning the revenue during an accounting period and must be taken into account for arriving at the correct amount of profit or loss for the period. If depreciation is not charged, the expenses and losses will be understated and the Profit and Loss Account will show higher profits making the concern pay higher taxes.

2.Ascertaining the true cost of production: Depreciation on machinery and other fixed assets in the factory is an important component of the cost of production specially when the unit is not labor intensive. So if no provision is made for depreciation, the cost calculations will be incorrect.

3.Presentation of true Financial position: The value of fixed assets reduces from year to year on account of their usage and passing of time. They must be shown in the Balance Sheet at their reduced values otherwise it will not reflect the true financial position of the business. Hence depreciation must be taken into account. It will enable the concern to show fixed assets at their proper values in the Balance Sheet.

4.Funds for replacement of assets: Charging depreciation reduces the profits available for distribution. It enables-the concern to retain a part of its profit and thus accumulate funds for the replacement of the assets as and when necessary.

The amount of depreciation to be charged to the Profit and Loss Account in respect of a particular fixed asset is affected by following factors:

1.Cost of the asset: Cost of the asset should include purchase price and all other costs incurred to bring the asset to usable condition like transportation costs erection charges, etc. It is to be noted that financial charges; such as interest on loan taken for the-purchase of the asset is not to be included in the original cost of an asset.

2.Estimated Working Life of the Asset: The useful or economic life of the asset can be stated in terms of time i.e., years, months, hours and in terms of quantity, i.e. number of units of output or any other operating measure such as kilometers in the case of lorries, motor vans, etc.

3.Estimated scrap value: Scrap Value (also called salvage value, residual value) refers to the estimated amount expected to be realized when the asset is sold at the end of its useful life. While the original cost of an asset can be correctly determined, useful life and salvage value can only be estimated, based on certain assumptions.