What depreciation is and why it is charged

A new machine is shiny and works at full speed. After five years of use it is worn, rusty and slower, and nobody would pay its old price for it. A phone bought for ₹15,000 three years ago will not sell for ₹14,000 today, when a better one costs less. This fall in value is depreciation.

In accounting, depreciation means spreading the cost of a fixed asset over the years it is used. It applies to tangible fixed assets: buildings, machinery, furniture, vehicles, office equipment. It does not apply to current assets like cash or stock, and land is not depreciated because it does not wear out.

Depreciation is a non-cash expense. No money leaves the business when you charge it; the money was spent when the asset was bought. Depreciation simply writes off that earlier spending, bit by bit, against the years that benefit from the asset.

Two similar words: depletion is used for natural resources that get used up, like mines, quarries and oil wells. Amortisation is used for intangible assets, like patents, copyrights and goodwill.

Why does value fall?

• Wear and tear from use: of two cars of the same model, the one driven less is worth more.
• Passage of time: even a car that stays parked loses value.
• Expiry of legal rights: a patent or a lease runs out after a fixed number of years.
• Obsolescence: a better or faster model arrives, so the old one is replaced although it still works.
• Abnormal factors: an accident, a fire or a flood.

Why charge it? To match each year's cost with that year's revenue, to show the true profit, to show a true financial position, because the tax law allows it as a deduction, and because company law requires it. Depreciation is charged even if the asset's market value goes up: it spreads cost, it does not track the market price.