Depreciation is the systematic reduction in the value of a tangible asset over its useful life due to wear and tear, usage, or obsolescence.
How It Works:
- A business purchases an asset such as machinery.
- The cost is spread over its useful life.
- A portion of the asset value is expensed each year.
- The asset value reduces over time in the books.
- Depreciation is recorded in financial statements.
Benefits:
- Helps in accurate financial reporting
- Provides tax advantages
- Reflects true asset value over time
- Aids in budgeting for replacements
Example:
A machine worth ₹10,00,000 with a useful life of 10 years is depreciated by ₹1,00,000 annually using the straight line method.