4.2. Causes of Depreciation

● Physical Wear and Tear ○ As assets like machinery or vehicles are used, they gradually lose their value due to physical wear and tear. ○ Example: A machine loses its value over time as it undergoes regular use in production.

Physical wear and tear occurs when assets are actively used over time. This is a natural process where the parts of an asset degrade due to regular usage. For instance, a machine in a factory will gradually become less efficient as components wear down from continuous operation. This degradation ultimately leads to a decrease in the asset's value.

Think of a new bike that you use every day. Initially, it shines and performs well, but over the months, the tires wear out, the paint chips, and the gears may not shift as smoothly. Because you have been riding it regularly, it starts to lose market value compared to a brand-new bike. Similarly, machinery operates under the same principle of depreciation due to physical wear.

● Obsolescence ○ Assets may become obsolete due to advancements in technology, making them less useful or valuable. ○ Example: Old computer equipment may be outdated by newer, more efficient models.

Obsolescence happens when an asset becomes outdated due to technological advancements or changes in consumer preferences. For example, older computers may not support new software, making them less desirable. As technology advances, newer models offer better performance and features, leading consumers to deem earlier versions as less valuable and effectively reducing their market price.

Imagine your smartphone. If you bought a smartphone five years ago, it might struggle to run new apps that require more processing power or updated operating systems. Meanwhile, the latest models may have faster processors and advanced features like better cameras or augmented reality capabilities. In the market, your old phone experiences a sharp decline in value compared to new models, illustrating obsolescence.

● Efflux of Time ○ Some assets lose value simply as time passes, even if they are not used intensively. ○ Example: Buildings may depreciate over time due to natural aging and environmental factors.

The efflux of time refers to the natural depreciation of an asset simply due to the passage of time. Even if a building isn't used much, it will still face decay from environmental factors like weather, which can deteriorate materials such as wood, concrete, or roofing. Additionally, zoning changes or shifts in the neighborhood could affect property value independently from physical conditions.

Consider an old family home that stands unused for years. Despite it being intact, the roof may begin to leak, paint can fade, and the interior might feel outdated compared to newer homes. Over time, this property is worth less not because of how much it has been used, but simply because it has aged. This process exemplifies how time contributes to the depreciation of assets.

● Inadequate Maintenance ○ Lack of proper care or maintenance can accelerate depreciation of assets. ○ Example: Failure to maintain a vehicle can lead to quicker wear and tear.

Inadequate maintenance refers to the failure to properly care for an asset, leading to accelerated wear and tear. Regular servicing such as oil changes, system checks, and repairs help extend the life of assets like cars or machinery. If these tasks are neglected, the asset can deteriorate much faster and lose value more quickly than it otherwise would have.

Imagine a car that you regularly bring in for service versus a car that never gets checked. The well-maintained vehicle runs smoothly, retains its value longer, and has fewer issues. On the other hand, the neglected car may develop serious problems like engine failure or brake issues, causing its value to drop significantly over time. In this way, maintenance directly influences how quickly an asset depreciates.

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