Date of Award
Business, Accounting & Economics
Perhaps the best known and most widely accepted definition of depreciation is the one formulated by the Committee on Terminology of the American Institute of Accountants. This acceptance is most likely due to the increasing importance of the AIA in the accounting field. The definition is a relatively new outlook on the subject but appears to be the most adequate yet formulated. The definition is as follows: Depreciation accounting is a system of accounting which aims to distribute the cost or other basic value of tangible capital assets, less salvage, over the estimated useful life of the unit in a systematic and rational manner. Depreciation for the year is the portion of the total charge under such a system that is allocated to the year.
From the definition it is implied that depreciation may be related to all forces, economic as well as physical, which terminate the life of the asset. It is also evident that depreciation is applied to the investment in the asset rather than to the asset itself.
FACTORS OF DEPRECIATION In order to understand fully the meaning of this definition it is necessary to review the factors that make up depreciation. For purposes of discussion they will be divided into physical factors, functional factors, and contingent factors.
PHYSICAL FACTORS Included in the division of physical factors of depreciation are wear, tear, action of the elements, and passage of time.2 These include only those actions which terminate the life of the asset because of its being worn out.
FUNCTIONAL FACTORS The functional factors are obsolescence, inadequacy and supersession. They are the economic factors in the determination of depreciation. Obsolescence is the loss of usefulness because of progress of the arts or other external causes such as changes in consumer demand, legislation, or regulation leading to reduction of further production of the product. Inadequacy is the loss of usefulness brought about by a business change. This is demonstrated in a situation where the executives of a business would decide that it would no longer be profitable to manufacture a product. The asset which aided in the manufacture would be discontinued from further use. Supersession occurs when one asset is replaced by another asset which operates so much more efficiently or less expensively than the old one, it is profitable to discard the old asset and install the new one.
Schneider, James, "Depreciation Of Fixed Assets" (1959). Business, Accounting and Economics Undergraduate Theses. 46.