Objectives for providing depreciation

Show true and fair view of financial statements

Financial Statements are made on historical cost basis. It means that the transactions are recorded in books of accounts at purchase price. In case of assets however the value of assets is reduced due to usage or passage of time continuously. So it is right to reduce the value of assets every year to the extent expected. If assets continue to be shown at purchase price in balance sheet then it may not show true and fair picture

Determine correct cost of production

Since the assets are also used in the production process so the value of asset depreciated should be considered as part of cost of production.

Provide funds for replacement

Suppose a business has profit before charging depreciation of Rs 1000 and depreciation for the year is Rs 200. If depreciation is not charged then final profit will be Rs 1000 which may get distributed among the shareholders as dividend. Now after the useful life of assets gets over the business will not have funds to buy the new asset for replacement.

Instead suppose Rs 200 is shown as an expense in profit and loss. Now final profit will be Rs 800 which may only be distributed among shareholders as dividend. Rs 200 every year continue to remain in business. This way a fund is created and Rs 200 every year is added to it. When the useful life of assets comes to an end the business will have funds ready for purchase of new asset

Determine correct profit or loss

Since assets are also getting used in generating revenue and profits for the business so it is right to charge depreciation as an expense while determining the net profit or loss of the business

Legal Compliance

Most of the commercial laws like Income Tax Laws, Company Laws have legal provisions for providing depreciation. Such provisions are mandatory and has to be complied with

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