Question

State briefly the need for providing depreciation

Answer 1

The needs for providing depreciation are given below:

1. To ascertain the correct profit or loss: Correct profit or loss can be ascertained when all the expenses and losses incurred for earning revenues are charged to Profit and Loss Account.

Assets are used for earning revenues and its cost is charged in form of depreciation from Profit and Loss Account.

2. To show true and fair view of financial statements: If depreciation is not charged, assets will be shown at higher value than their actual value in the balance sheet.

Consequently, the balance sheet will not reflect true and fair view of financial statements.

3. For ascertaining the accurate cost of production: Depreciation on the assets, which are engaged in production, is included in the cost of production.

If depreciation is not charged, the cost of production is underestimated, which will lead to low selling price and thus leads to low profit.

4. To provide funds for replacement of assets: Unlike other expenses, depreciation is non-cash expense.

So, the amount of depreciation debited to the profit and loss account will be retained in the business.

These funds will be available for replacement of fixed assets when its useful life ends.

5. To meet the legal requirement: To comply with the provisions of the Companies Act and Income Tax Act, it is necessary to charge depreciation.