Depreciation is a permanent, continuing and gradual shrinkage in the book value of fixed assets. It is based on the cost of assets consumed in a business and not on its market value. According to Accounting Standard-6, depreciation is “a measure of the wearing out, consumption or other loss of value of depreciable asset arising from use, effluxion of time or obsolescence through technology and market-change.” It is allocated over the expected useful life to charge a fair proportion of depreciable amount in each accounting period. In accounting, depreciation is that part of the cost of a fixed asset which has expired on account of its usage and/or lapse of time, and is treated as an expense charged against revenue.

The need for charging depreciation arises to ascertain true and fair profit or loss. Since depreciation is a non-cash operating expense, it ensures that the cost of a fixed asset is spread over its useful life, matching expenses with revenues. This prevents overstatement of profits in the year of purchase and understatement in later years, and provides a realistic view of the financial position.

The causes of depreciation include: (i) Wear and Tear due to use and/or passage of time; (ii) Expiration of Legal Rights such as patents or leases; and (iii) Obsolescence, which results from technological advancements or market changes making the asset outdated even if it is physically intact.