Fundamentals of Financial and Cost Accounting · Depreciation (Straight Line and Diminishing Balance Methods)

Meaning and Causes of Depreciation in Accounting

Updated 10 October 2026 · Fact-checked

Depreciation is the systematic allocation of the depreciable cost of a fixed asset over its useful life. It is caused by wear and tear, obsolescence, passage of time and similar factors. You charge it to the profit and loss account each year. It is a non-cash expense that spreads cost, not a measure of market value.

Understand Meaning and Causes of Depreciation

A business buys a machine for ₹5,00,000. It will not produce for one year only. It will serve for many years. If you charge the whole ₹5,00,000 as an expense in year 1, profit for that year looks too low and profits of later years look too high. This breaks the matching idea: costs should be set against the revenue they help earn.

Depreciation solves this. It spreads the cost of the asset, less its expected scrap value, over the years in which the asset is used. Each year's share is charged as an expense.

Assets lose their usefulness for several reasons. Wear and tear is physical use: machines, vehicles and furniture get worn out by working. Obsolescence is becoming out of date because of new technology or changed fashion or demand, even if the asset is physically fine. Passage of time applies to fixed-term rights, such as a lease or a patent, whose cost is amortised over the term as time runs out. Leasehold land is generally amortised over the lease period, while buildings on it are depreciated. Other causes include accident or abnormal damage, and exhaustion of a natural resource as it is extracted.

The objectives of charging depreciation are: to show the true profit by matching cost with revenue; to show the asset in the balance sheet at a fair book value (cost less depreciation); to spread the cost of the asset over its life; to reduce the profit available for distribution, so that some resources can be kept in the business; and to comply with accounting standards and, in many cases, with law and tax rules.

Note that charging depreciation does not by itself set aside any cash. Cash is set aside only if you deliberately create and invest a sinking fund or replacement fund.

Remember that depreciation is a non-cash expense. No cash leaves the business when you charge it. It is also about cost allocation, not about the current market value of the asset. Land is normally not depreciated because it has an unlimited life.

Key formulas to remember

Depreciable amount: Depreciable amount = Cost of asset − Estimated residual (scrap) value; This is the total amount to be written off over the useful life. Cost includes purchase price plus freight, installation and other costs to bring the asset into use.
Book value (written down value): Book value = Cost − Accumulated depreciation; This is the value shown in the balance sheet. It need not equal market value.
Depreciation vs depletion vs amortisation: Depreciation: tangible fixed assets | Depletion: natural resources | Amortisation: intangible assets; Depreciation applies to machinery, buildings, vehicles. Depletion applies to mines, quarries, oil wells. Amortisation applies to intangibles such as patents, copyrights and goodwill. Fixed-term rights such as a lease or a patent lose value with passage of time, and their cost is amortised over the term. Leasehold land is generally amortised over the lease period, while buildings on it are depreciated.
Main causes: Wear and tear, obsolescence, passage of time, accident, exhaustion; Learn these as the standard list of reasons an asset loses value.

How to solve Meaning and Causes of Depreciation questions

Most questions on this topic ask you to define, identify a cause, state an objective or tell apart similar terms. Use this method.

1Read the question and find the keyword: meaning, cause, objective, or a pair of terms to distinguish.
2If it asks for meaning, think: allocation of cost over useful life, not valuation.
3If it describes a situation, ask what made the asset lose usefulness: use or physical wear, new technology, time running out, or extraction.
4Match the asset type to the term: tangible asset gives depreciation, natural resource gives depletion, intangible asset gives amortisation.
5If it asks for an objective, pick the one linked to matching cost with revenue, true profit or fair book value.
6Remove options that say depreciation is a cash outflow, a fund, or a market value adjustment.
7If a number is given, compute depreciable amount as cost minus scrap value before anything else.

Quickest way: Keyword matching

When to use it: Use this for one-line theory MCQs where you have under a minute.

Spot the clue word in the stem: machine use means wear and tear; new invention means obsolescence; lease or patent expiry means passage of time; mine or oil well means depletion.
Link intangible assets such as patents and goodwill to amortisation.
Reject any option calling depreciation a source of cash or a market value fall.
Choose the option that mentions allocation of cost over useful life.

Common mistakes in Meaning and Causes of Depreciation

Saying depreciation is a fall in the market value of the asset.
The everyday meaning of the word is loss of value.
Fix: In accounting it is allocation of cost over useful life. Book value can differ widely from market value.
Treating depreciation as a cash expense or a fund of cash.
It appears as an expense, so students think money is paid.
Fix: No cash goes out. Charging depreciation only reduces profit and the book value of the asset.
Using depreciation for mines and patents.
The three terms sound alike.
Fix: Depreciation for tangible fixed assets, depletion for natural resources, amortisation for intangibles.
Depreciating land.
Land is a fixed asset, so students assume all fixed assets are depreciated.
Fix: Land normally has an unlimited life, so it is not depreciated.
Ignoring scrap value when finding the amount to be written off.
Students use full cost as the base.
Fix: Depreciable amount is cost minus estimated residual value.
Thinking obsolescence only happens when the asset is physically damaged.
Students link all loss of value to physical use.
Fix: Obsolescence is about being out of date because of technology or demand, even if the asset works well.

Worked examples

Example 1

A textile unit in Surat has a machine that still works well, but a new machine produces twice the output at lower cost. The old machine is rarely used now. Which cause of depreciation does this describe? (A) Wear and tear (B) Obsolescence (C) Passage of time (D) Depletion

Show the solution

The machine is physically fine, so wear and tear is not the main cause.
Its usefulness has fallen because newer technology is available.
This is the definition of obsolescence.
Passage of time applies to fixed-term rights, and depletion applies to natural resources, so both are out.

Answer: (B) Obsolescence

Example 2

A machine costs ₹6,00,000, including installation. Its estimated scrap value is ₹60,000. What is the total amount to be charged as depreciation over its life, and what is the book value after ₹2,00,000 of depreciation has been charged in total? (A) ₹5,40,000 and ₹4,00,000 (B) ₹6,00,000 and ₹4,00,000 (C) ₹5,40,000 and ₹3,40,000 (D) ₹6,60,000 and ₹4,60,000

Show the solution

Depreciable amount = ₹6,00,000 − ₹60,000 = ₹5,40,000.
Book value = Cost − Accumulated depreciation = ₹6,00,000 − ₹2,00,000 = ₹4,00,000.
Scrap value is not subtracted when finding book value at this point; it is used only for the total to be written off.

Answer: (A) ₹5,40,000 and ₹4,00,000

Exam tips

Learn the three terms in one line each: depreciation for tangible assets, depletion for natural resources, amortisation for intangibles.
Questions often describe a situation. Find the clue word and name the cause.
Always subtract scrap value to get the depreciable amount, but not when finding book value from accumulated depreciation.
Eliminate options that call depreciation a cash outflow or a market value measure. They are almost always wrong.
With no negative marking, answer every question even if you must guess between two options.

Practice questions from Depreciation (Straight Line and Diminishing Balance Methods)

Meaning and Causes of Depreciation in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Meaning and Causes of Depreciation: frequently asked questions

What is depreciation in accounting?

It is the systematic allocation of the depreciable cost of a fixed asset over its useful life. It is charged as an expense each year. It does not measure market value.

What are the main causes of depreciation?

The main causes are wear and tear, obsolescence, passage of time, accident and exhaustion of natural resources. Wear and tear is physical use. Obsolescence is becoming out of date.

What is the difference between depreciation, depletion and amortisation?

Depreciation applies to tangible fixed assets like machines. Depletion applies to natural resources like mines and oil wells. Amortisation applies to intangible assets like patents and goodwill.

Why is depreciation charged if no cash is paid?

It matches the cost of the asset with the revenue it helps earn over the years. This gives a truer profit and a fair book value of the asset in the balance sheet.