Why does assets depreciate and why does depreciation occurs?
Assets depreciate because they lose value over time due to various factors such as wear and tear, obsolescence, or technology advancements. Depreciation occurs because of two main reasons:
1. Physical Deterioration: Physical assets, like machinery or vehicles, gradually lose value due to regular use, aging, or exposure to elements. This wear and tear result in reduced efficiency, increased maintenance costs, decreased performance, and decreased market value.
2. Functional Obsolescence: Over time, assets can become outdated or obsolete due to advancements in technology, changing customer preferences, or new industry standards. This can lead to a decrease in demand and value for the asset as newer and more efficient alternatives become available.
Depreciation is essential to accurately reflect the decrease in an asset's value over its useful life. It allows businesses to allocate the cost of the asset over its estimated lifespan, helping them match expenses with generated revenue. Depreciation also helps businesses track the replacement or repair costs needed to maintain an efficient production or operational level. Additionally, it enables accurate financial reporting and taxation by reflecting the true value of assets on balance sheets.