Objectives of Providing Depreciation
The following are the objectives of providing depreciation:
1. Knowledge of True Profits
When an asset is purchased, it is nothing more than payment in advance for an expense. For example, purchasing a building for $100,000 for business purposes will save rent in the future.
However, after a certain number of years, the building will become useless. The cost of the building is, therefore, nothing except paying rent in advance for years.
Any paid rent would have been charged as an expense to determine the true profits made by the business during a particular period.
Therefore, the amount paid for the purchase of the building should be charged over the period for which the asset would be serviceable.
2. True Financial Position
The assets depreciate in their value on account of various factors.
To present a true state of affairs of the business, the assets should be shown in the balance sheet, at their proper values.
3. Replacement of Assets
The business uses assets to earn revenue. On account of constant use or lapse of time and similar other causes, a stage may come when the assets need to be replaced. Providing depreciation retains a part of the business profits, which can purchase new assets.
4. Correct Cost of Production
Depreciation is a cost of production, and if depreciation is not charged, the cost of production so determined will not be correct.