Finance and Management - 30

In the earlier blog, we looked at the relation between Balance Sheet and the PnL account. In the next few blogs we look at the various items within a PnL account. Today we begin with the term "Depreciation".

It should be quite intuitive that when we buy an item (let's assume a computer table) by paying cash we have an equation,

Price of Item = Cash Paid

Now, when we put it up in the balance sheet today - we would add a value equal to the price of the computer table on the assets side, and reduce the cash head by the amount equal to the cost of the computer table. Now, this is what we have when we have made the purchase say today; but what would the scene be after let’s say 1 year! Well this is a dicey question, since in the one year there are many things that could have happened with the computer table (lets worry only about the table now not the cash side of it - makes life simpler. The cash has now manifested as the asset and let’s not worry about the cash spent).

In the one year since purchase, the table could have broken or I could have disposed it off as junk, or I would have sold it or it might just lay there in the office with some usage by various people in the office. In any case the value of the computer table wouldn’t be the same as the one it was purchased it; it would be lower than that. As the years of its usage grow, it resale value let’s say keeps reducing. This is factored in even in the accounting world and we call the process of doing this as "Depreciation"

So, we could define "Depreciation" A method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes.

One thing we need to remember is that not every asset would have the same rate of depreciation; it would vary (and would be defined by the accounting policy of the company). There are also some assets whose value increases with time, these needs to be addressed differently.

Read in Kannada:
http://somanagement.blogspot.com/2011/09/blog-post_1401.html