Depreciation: An Overview

Depreciation is an allowance for the decline in an asset's value. It has two aspects, an accounting aspect and a practical aspect.

In accounting terms, depreciation is the process of allocating the cost of tangible property against revenue over a period of time, rather than deducting the cost as a cash expense in the year of acquisition. Generally, at the end of an asset's life, the sum of the amounts set aside for depreciation each accounting period will equal original cost less salvage value (the value of an asset at the end of its life).

In practical terms, depreciation suggests a gradual decline in an asset's market value because of use and wear and tear.

Good accounting and financial management practices require that an organization take both the cost expiration and the declining market value of an asset into account. The cost expiration of an organization's assets must be recognized if the cost of its operations is to be realistic. Also, the decline in the market value of those assets must be considered.

Generally, to be depreciated, a fixed asset must:

• Be used in the organization's operations,
• Have an estimated life greater than 1 year,
• Be subject to wear, decay, or expiration, and
• Be fully installed and ready for use.