Objectives of providing for depreciation

26th November 2020 1 By indiafreenotes
  • For the presentation of assets in the balance sheet at their proper value: Depreciation must be charged to each fixed asset for the true and fair presentation of assets in the balance sheet. The depreciation is deducted from the cost or book value of assets each year.
  • For the replacement of assets: The fund equal to the amount of the depreciation is created which will remain in the firm. After the expiry of the life of asset, the same fund can be utilized to replace the new asset.
  • For the determination of correct cost of production: Correct cost of production cannot be ascertained if the depreciation is not charged to the fixed assets. Thus, it is necessary to include amount of depreciation in the calculation of cost of each product.
  • For the determination of true profit or loss: Depreciation is also an expense like repair and maintenance which must be included in profit and loss account to ascertain the correct profit or loss of a business for the year.

Objectives or Need for Providing Depreciation:

(a) To ascertain true profits:

Depreciation is a charge for capital assets used in earning profits and therefore, it should be viewed as business expenditure. Unless proper charge for this expense is made in accounts, the correct profit cannot be ascertained.

(b) To show the assets at their proper values:

Depreciation must be accounted for in order to show the assets at their proper values and thereby present a true and fair view of the financial position of the business. Unless depreciation is provided, the value of the assets will be overstated in the Balance Sheet and it will not reflect the true and fair view of the business.

(c) To create funds for replacement of assets:

Depreciation is non-cash expenditure. Hence, the amount of depreciation charged to Profit and Loss account remains in the business and the amount thus accumulated during the working life of the asset provides funds for its replacement at the end of the working life of the asset.

(d) To keep the capital in tact:

If depreciation is not charged, the amount of profit will be inflated. If such profits are distributed among the owners, then it will amount to the distribution of fixed capital from the business. In the long run it will affect the financial health of the business.

(e) Statutory Need: Provision of depreciation is a statutory need:

Section 205 of the Indian companies Act has made compulsory for a joint stock company to provide for depreciation before distributing the profits as dividends.