Depreciation – Theory Based

Depreciation means the systematic allocation of the cost of a depreciable asset to expense over the asset’s useful life.

Imagine a mobile phone that you have purchased a year ago. Your mobile phone during this one year period could have undergone wear and tear, outdated technology, physical damage and etc. So the next time when you are trying to sell this mobile phone, you need to lower the price because of the damages that your mobile phone has already undergone. Let’s say your original mobile phone costs you $600, after a year of using, you sell it for $400. Now, the $200 difference is the depreciation. Note that depreciation is an EXPENSES. This applies to most limited lifetime assets. People tend to be confused on what will depreciate. Strictly speaking, anything that you think will grow old will depreciate. But, there are circumstances when you don’t depreciate asset, asset such as land and investment are those that might not depreciate (you can think of those as something that last forever).

You should note that depreciation rationale lies in the concept of Matching Principle.

There are three ways of calculating depreciation:

1) Straight Line Method

2) Reducing Balance Method or Diminishing Method

3) Revaluation Method (Applicable for A Level students, usually appears in Manufacturing Account)