Depreciation (Also see Straight-line Depreciation and Accelerated Depreciation) is probably one of the terms that you will often hear from the bookkeeping firm in Johor Bahru when they are explaining to you how they are handling the accounting tasks related to the assets that you own. They will tell you that depreciation means the carrying amount of fixed assets (Also see Provisions for the Depreciation of Fixed Assets) your company owns has reduced, and they will charge the depreciation expense in the income statement of your company.

At the first time you learned about this concept, you may have tons of doubts. “Why do we need depreciation?” may be one of the questions that popped out in your mind. In fact, many factors can lead to depreciation. Some of them include the use of the asset’s useful life, wear and tear of assets arising from their usage, the advancements of technology, and so on.

First and foremost, depreciation is necessary because some of the fixed assets (Also see How to Calculate the Carrying Value of Assets?) will have a specific useful life. Some of the products may have a particular lifespan in which the manufacturer has provided in consumption units. As an instance, a machine can operate for 20000 hours in total. Thus, business owners need to allocate the cost of that asset based on the usage or consumption.

Apart from this, wear and tear are also one of the crucial factors that lead to the depreciation of the company’s assets. As the company uses the assets continuously, they will get deteriorated or begin to wear off. Some of the examples include plant and machinery that the company would use in the manufacturing process. This means that the company needs the machines to run continuously, and this will cause the capacity or the performance of those machines to diminish as time passes. At the same time, their values in the market will decrease too. Thus, depreciation is necessary so that the value of those plants and machinery in the company’s books of accounts will reduce correspondingly too.

Due to the advancement of technology, the fixed assets (Also see Disposal of Fixed Asset in a Company) will experience a fall in their values in the marketplace over time. This is because the new versions of those assets with more advanced technological features will appear in the market. These new assets will be able to provide users with more benefits compared to the old versions. Thus, the recoverable amount of those old assets, as well as their requirements in the market, will decrease gradually. In this case, depreciation is needed so that business owners can show the values of those assets at a reasonable amount in the financial statements.

Besides, business owners need to ensure that their companies have followed the provisions mentioned in the accounting standards that they chose to implement. One of the principles that they need to follow is the matching concept in accounting. According to this concept, business owners should report the expenses in the accounting period where the business has earned the related income in the company’s profit and loss statement. Such expenses include the depreciation expense; hence business owners should charge them in the profit and loss statement as well.

In short, depreciation is crucial for business owners to reflect the financial position of their business accurately. This is because they will write off the used costs or portion of those assets in the company’s profit and loss statement for that accounting period.