Obsolescence is different form depreciation

Obsolescence is different form depreciation. It is generally used to indicate a sudden loss in the value of a asset not due to wear and tear. It arises because a machine has to be discarded in favor of one better adopted to its purpose and giving better result. It is also called external depreciation as the asset has to be withdrawn before the end of its useful life owing to the operation of external factors like technological improvements in the existing machines. It may also arise due to change in the product or change in the method of manufacture. It may also arise because an asset is not up to the standard to cope with the increasing competition in the market. It may arise either in case of fixed assets.

The Following methods may be used for accounting of obsolescence:

• The rate of depreciation should be increased in order to include the element of obsolescence provided it can be foreseen and predicted. Thus if a machine is purchased for 800$ and has 8 year of effective life but is likely to be out of date in 5 years, then depreciation should be 160$ p.a. and not 100$ p.a.
• The loss resulting from the obsolescence may be written off to profit and loss account of that year in which it arises, provided the amount is small. If the amount is big, then it may be treated as deferred charge and may be spread over a number of years. The loss to be written off will be represented by the depreciated value of the asset on the date when it is discarded less reliable value, if any.
• A suitable amount every year may be credited to Obsolescence Reserve Account and loss arising from the discarding of asset is debited to Obsolescence Reserve Account.