Depreciation arises from several causes, the chief of which are:
1. Wear and tear, due to use.
2. Decrepitude or age, due to lapse of time.
3. Obsolescence, due to a changed demand for the article or to an advance in the arts which makes the continued use of the asset uneconomical.
4. Inadequacy, brought about by several causes, one of which may be the change in the market which renders the asset inadequate for furnishing the product or service in the amount required.
Obsolescence and inadequacy, because of their very nature, are usually difficult of determination and frequently cannot therefore be considered in determining the amount of depreciation accrued at a given time. Where measurable they should, of course, be taken into account. Depreciation due to lapse of time is calculable on a time basis. Depreciation due to wear and tear is calculable on the basis of the use to which the asset has been subjected. It is in practice difficult to separate these two types of depreciation. The estimate for depreciation is in the majority of cases made on a time basis. In manufacturing establishments, oftentimes a use or output basis proves more satisfactory. These more difficult problems met in the determination of depreciation are discussed in Volume II. Here only the most usual method of depreciation estimate on a time basis, known as the straight-line method, will be explained.
For determining the periodic amount of depreciation of any asset it is necessary to know: (1) the original cost of the asset; (2) its scrap value, that is, the estimated value as scrap on the day it is junked; and (3) the estimated life of the asset in years or fiscal periods. The following symbols will be used in working out the formula:
| V₁ | = | Original value. |
| Vₙ | = | Scrap value at the end of n years, its estimated life. |
| n | = | The estimated number of years in the life of the asset. |
| D | = | The amount of depreciation during a period. |
| r | = | The rate to be applied to V₁ in order to determine D. |
It is apparent that V₁-Vₙ is the amount to be depreciated over the life of the asset. The amount to be charged off periodically as depreciation is, therefore:
| V₁ - Vₙ |
| ——— |
| n |