Explain the term Depredation. Why it is necessary to provide depreciation?
Meaning of Depreciation:
Depreciation is permanent, continuing and gradual reduction on the book value of fixed assets due to normal wear and tear, passage of time, obsolescence or any other similar cause. Some of the important definition are, Depreciation is the gradual decrease in the value of an asset from any cause. It is the permanent and continuous diminution in the quality, quantity or value of an Asset.
Depreciation represents loss or diminution in the value of an asset consequent upon wear and tear, obsolescence, deflation of time or permanent fall in market value.
Characteristic of Depreciation
- It is related to Decipherable fixed assets only.
- It is a fall in the book value ‘of appreciable fixed asset.
- It is a permanent, continuing and gradual, shrinkage in the book value of a fixed asset.
- The fall in the book value of an asset is due to the use of the asset in business operations, effusion of time, obsolescence, expiration of legal rights or any other cause.
- It is a systematic allocation of cost of an asset on the basis of its useful life.
Objectives or Necessity for Providing Depreciation:
The following are the objectives of providing depreciation:
To Ascertain the True and Fair View of the Results of the Operations. To find out net profit or for an accounting period, we add the revenue of that period and deduct all expenses incurred in that period for earning those revenues. One such expense is the portion of the cost of the fixed assets that has expired during the year. Unless depreciation is charged, the true profit of a particular period cannot ascertained.
To present a true four view of Financial position of the business, the assets must be valued correctly on the Balance Sheet. Unless depreciation is charged, the assets may’ be overstated in the Balance Sheet.
To Ascertain the True and Fair View of the Cost of Production. Depreciation should be taken into consideration for calculating the cost of production. If it is not done, the cost records would not give a true and fair view of the cost production
To make provision for replacement of asset If depreciation is not provided the profit of the concern will be overstated and can be distributed among shareholder as dividend. After the end of the working life of the asset, there will be no provision or funds at the disposal of the concern and has to borrow for acquiring new assets. For the replacement of asset, depreciation must be provided.
To comply with legal requirements. In case of companies, it compulsory to change depreciation on fixed assets before it declares dividend.
Profit or loss on sale. A fixed asset is to be sold at the end of its useful life or may be even before. If no depreciation is provided, the written down value of the asset cannot be ascertained. In effect, the profit or loss on sale of asset can not be determined.