Role of Depreciation In Accounting
The dictionary meaning of the word depreciation is decrease or reduction. However, depreciation has a different connotation in accounting terminology. Accounting depreciation is described as that part of a tangible asset’s value which decreases through its useful life. The concept of depreciation is extremely important in financial accounting because it facilitates in upholding its basic assumptions, accruals and fair presentation. Moreover, depreciation affects the financial condition of an enterprise as well as its income for a specified accounting period.
The accumulated depreciation is offset against the value of a depreciable asset in financial statement. The current depreciation expense is deducted from the gross profit for determining the earnings of a business. Moreover, accounting depreciation affects both income statement as well as balance sheet.
Depreciation is related to capital expenditure. Always remember that capital expenditure is not recorded in the form of an expense for the period during which it has been incurred. Moreover, capital expenditure influences the financial position of a business, not the income. However, the money utilized for acquiring a non-current depreciable asset is not considered to be a normal expense.
Accounting depreciation is derived from the accrual assumption. Therefore, the origin of depreciation should not be attributed to a decrease in the value of assets over a period of time. According to accrual assumption the entire revenue during a period must be matched against the expenses incurred for its generation. Since a depreciable asset is utilized over various accounting periods, cost must be identified and spread across the accounting periods.
Despite the fact that depreciation leads to a decrease in the net book value (cost less accumulated depreciation), the objective of the concept is allocation of costs over a definite period of time. Therefore, one must not assume that the value of asset decreases over a period of time.
The main role of deprecation is to maintain the accruals. Moreover, it affects the position of assets as well as the income of an entity over a particular period of time. In general, depreciation is the conventional technique for identification of capital expenditure over different accounting periods. Besides this, since land and current assets do not witness a decrease in value, emphasis is laid on the depreciable assets.