Mention the main purposes of providing depreciation.

Auditing and Assurance Revision Questions and Answers

Answer

Purposes of providing Depreciation:

 To keep capital intact: One of the purpose of providing depreciation on assets is to retain in the business out of the profits in each year, an amount equal to the proportion of the cost of the asset employed in the business that has run off, estimated on the basis of the period of its working life and its scrap value. If, depreciation had not been charged, the net income would have been overstated over the years of the life of the asset, and if the same was withdrawn or distributed as dividends, the business would have no funds for the replacement of the asset.

 To ascertain cost accurately: Unless a proper charge on account of depreciation is included in the Profit and Loss Account, the true cost of manufacture of different products will not be ascertained.

 To charge initial costs against earnings: The objective of depreciation accounting is to determine on a scientific basis, the proportion of the cost of a machine which must be charged in the accounts of each year during which the machine will be used. Each accounting period is to be charged against profits a fair proportion of the cost of fixed assets.

 To Prepare true and fair statements: Depreciation is provided on the assets to show its value at true cost and to show the profit at real. Unless depreciation is provided, the balance sheet and profit and loss account will not be true and fair.

Depreciation is to be provided on the book value of assets, irrespective of the market price of the assets at the year-end may be either more or less than its book value.



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