Anita Holmes, age 14, of Dubuque, Iowa, for her question:
CAN YOU EXPLAIN DEPRECIATION?
Depreciation in accounting is a decrease 1n the value of capital assets invested in a business, resulting from such causes as physical wear and tear in ordinary use, deterioration or obsolescence.
An example of wear and tear can be found in the aging of a company's machinery. Deterioration, which is primarily from action of the elements, can be found in the aging of buildings or the erosion of farmlands. Obsolescence can be caused by technological changes and the introduction of new and batter machinery and methods of production.
The primary aim of the accountant in recording and reporting depreciation is to present a true and undistorted picture of net income and the value of capital assets owned by a business. The provision of s means for replacing such assets as they wear out may be looked upon as an additional function of depreciation accounting.
The method most widely used by accountants in calculating periodic depreciation is the so called straight line method, in which the rate of depreciation is constant for the entire working life of the capital assets.
With the straight line methods, a machine which cost $1,100 and is assumed to have a 10 year useful life and a scrap value of $100 at the sad of 10 years would have an annual depreciation rate of 10 percent, or $100 per year.
When the decrease in value of a capital asset is not constant over a period of time, a second method called the service unit method or unit of production method is used. Here the scrap value is deducted from the cost of the asset and the remainder divided by the number of units (for example, miles or loads in the case of a truck) the asset is expected to yield.
A third method, using a constant percentage of the remaining value (depreciated value) each year, gives effect to the substantial loss in value incurred immediately after acquisition. Star Break
In the method using a constant percentage, an effect is also given to account for the relatively minor cost of upkeep new equipment will have just after it is acquired.
During the latter years, however, the annual depreciation diminishes, but the coat of maintenance tends to increase. As a result, an approximately uniform charge is made against business income each year for the use of the asset as reflected in the varying ratio between depreciation.and maintenance. The accumulated reduction in value resulting from use and obsolescence is shown as a depreciation reserve.
Depreciation in the sense of a depreciated currency, that is, a currency that has declined in value, would fall in the classification of devaluation.
Devaluation in economics is the official act reducing the rate at which one currency is exchanged for another in international currency markets.
The lowering of a currency value by devaluation occurs when a country has been maintaining a fixed exchange rate relative to other major foreign currencies. A decline in a currency's value is known as a depreciation.