Objectives of providing depreciation

True Tamplin

Written by True Tamplin, BSc, CEPF®
Updated on June 22, 2021

The following are 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, if a building is purchased for $1,00,000 for business purposes, the effect of such a purchase with be saving in the cost rent in the future. But, 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 a period of years.
If the rent had been paid, it would have been charged as an expense for determination of the ture profits, made by the business during a particular period. The amount paid for the purchase of building should, therefore, be charged over a period of time for which the asset would be serviceable.

2. True financial position

The assets get depreciated in their value over a period of time on account of various factors as explained before. In order to present a true state of affairs of the business, the assets should be shown in the Balance Sheet, at their proper values. In case depreciation is not charged, the Balance Sheet will not show a true view of the state of affairs of the business.

3. Replacement of assets

The business uses assets for earning revenue. On account of constant use or lapse of time and similar other causes, a stage may come when the assets will need replacement. By providing depreciation a part of the profits of the business is kept in the business which can be used for the purchase of new assets as the old assets became useless.

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.

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