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Introduction:
An analysis of costs and profits for any
business operation requires recognition of
the fact that physical assets decrease in
value with age. This decrease in value may
be due to physical deterioration,
technological advances, economic changes,
or other factors which ultimately will cause
retirement of the property. The reduction in
value due to any of these causes is a
measure of the depreciation
Depreciation:
Physical depreciation
Functional depreciation
Physical Depreciation:
The measure of the decrease in value
due to changes in the physical aspects
of the property.
Wear and tear, corrosion, accidents,
and deterioration due to age or the
elements are all causes of physical
depreciation.
With this type of depreciation, the
serviceability of the property is
reduced because of physical
Functional Depreciation:
A loss in value of an improvement due
to functional inadequacies, often
caused by age or poor design.
Obsolescence:
This is caused by
technological advances or
developments which make an existing
property obsolete.
Continue.
Even though the property has suffered
no physical change, its economic
serviceability is reduced because it is
inferior to improved types of similar
assets that have been made available
through advancements in technology.
Other causes of functional
depreciation:
1. Change in demand for the service rendered
by the property, such as a decrease in the
demand for the product involved because of
saturation of the market
2. Shift of population center
3. Changes in requirements of public authority
4. Inadequacy or insufficient capacity for the
service required for termination of the need
for the type of service rendered, and
5. Abandonment of the enterprise.
Depletion
Capacity loss due to materials
actually consumed is measured as
depletion. Depletion cost equals the
initial cost times the ratio of amount
of material used to original amount
of material purchased.
Costs for Maintenance and
Repairs
The term maintenance conveys the idea
of constantly keeping a property in good
condition, repairs connotes the replacing
or mending of broken or worn parts of a
property.
Straight-line
Declining-balance
Sum-of-the-years-digits methods
Methods taking into account
interest
Sinking-fund
The present-worth methods.
Straight-Line Method
It is assumed that the value of the property
decreases linearly with time. Equal amounts are
charged for depreciation each year throughout the
entire service life of the property.