Whenever, any machine or equipment performs useful work, its wear and tear is bound to occur. This can be minimized up to some extent by proper care and maintenance but can't be totally eliminated. Its efficiency also reduces with the lapse of time and at one time it becomes uneconomical to be used further and replacements by another new unit.

Therefore we can say that efficiency and value of machine or asset reduces with the lapse of time during use, which is known as 'Depreciation', So some money must be set aside yearly from the profit, so that when the equipments becomes uneconomical, it can be replaced by the new one. Therefore, the initial cost of the machine plus installation charges plus repair charges minus scrap value is charged against overheads and is spread over the machine useful life.

For this purpose an account for the complete plant or individual equipment is opened in the Company's Books known as 'Depreciation Fund' or 'Sinking Fund'. This amount is deducted yearly from the profits and kept separately to have sufficient money for replacement at the end of useful life.



Suppose a factory owner purchases a machine for his production shop but after some duration a better machine comes in the market, whose production rate is very high and much economical. Although the old machine is efficient but becomes out of fashion and uneconomical due to the new better machine which has come in the

market. This is known as 'Obsolescence'. Consideration of this factor is of much important and some money also should also be set aside from the profit for this cause.

Hence, obsolescence is the depreciation of existing machinery or asset due to new and better invention or design of equipment or processes etc.

It is very difficult problem for the estimator to provide for the on-cost on obsolescence, because nobody can say when a revolutionary change in the machine is coming in the market. But is a general practice to reduce the life of machine so as to account the effect of obsolescence. Now the depreciation and obsolescence charges are calculated in the reduced life.

Suppose an estimator expects the life of machinery as 20 years then the depreciation rate will be 100/20=5%. By considering obsolescence also, its life may be taken as 15 years. Then the combined depreciation and obsolescence charges will be 100/15 = 6.66% instead of 5%. Therefore, the difference 6.66 - 5.00 = 1.66% will be obsolescence charges.

Also See: Causes of Depreciation , Indirect Expenses and Depreciation

Next Chapters

Estimating Procedure
Difference between Estimating & Costing
Depreciation & Obsolescence
Material Cost Calculation
Calculating Labor Cost
Direct and Indirect Expenses
Component Cost
Machine Shop Estimating
Forging and Forging Types
Starting an Organization
Welding Cost Estimation
Jigs and Fixtures
Qualities of an Entrepreneur
Starting Small Scale Industries
Budget and Budgetary Control
Supply & Law of Supply
Exchange and Barter Exchange
Classification of Market
Money and Types of Money
Trade Cycle
Break Even Analysis
Financial Management

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