Reasons for Depreciation

An asset starts to lose value as soon as it is purchased. For example, a car bought for S20 000 today may be worth Si8 000 next week, S15 000 next year, and Si000 in 10 years. This loss in value, called depreciation, occurs for several reasons.

Use-related physical loss: As something is used, parts wear out. An automobile engine has a limited life span because the metal parts within it wear out. This is one reason why a car diminishes in value over time. Often, use-related physical loss is measured with respect to units of production, such as thousands of kilometres for a car, hours of use for a light bulb, or thousands of cycles for a punch press.

Time-related physical loss: Even if something is not used, there can be a physical loss over time. This can be due to environmental factors affecting the asset or to endogenous physical factors. For example, an unused car can rust and thus lose value over time. Time-related physical loss is expressed in units of time, such as a 10-year-old car or a 40-year-old sewage treatment plant.

Functional loss: Losses can occur without any physical changes. For example, a car can lose value over time because styles change so that it is no longer fashionable. Other examples of causes of loss of value include legislative changes, such as for pollution control or safety devices, and technical changes. Functional loss is usually expressed simply in terms of the particular unsatisfied function.

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