QS Study

Need for Providing Depreciation:

Depreciation is a decrease in the price of an asset with the course of time, due in particular to wear and tear. All assets whose advantage is derived for a long period of time, generally more than one year period are called as Fixed Assets. These assets reduce in value year after year due to wear and tear or lapse of time. This reduction in value of Fixed Assets is called Depreciation.

The need for providing depreciation in accounting records arises due to any one or more of the following reasons.

To ascertain correct profit / loss: For proper matching of cost with revenues, it is necessary to charge depreciation against revenue in each accounting year, to calculate the correct net profit or net loss.

To present a true and fair view of the financial position: If the amount of depreciation is not provided on fixed assets in the books of account, the value of fixed assets will be shown at a higher value than it’s real value in the balance sheet. As such it will not reflect the true and fair financial position of the business. Hence, to present a true and fair view of the financial position of the business, it is necessary that depreciation must be deducted from the book value of the assets in the balance sheet.

To ascertain the real cost of production: For ascertaining the real cost of production, it is necessary to provide depreciation.

To replace assets: Depreciation is provided to replace the assets when it becomes useless.