Question

What is the purpose of depreciating an asset?

Answer 1

Purpose of Depreciating an Asset-

The purpose of depreciation is to match the expense recognition for an asset to the revenue generated by that asset. This is called the matching principle, where revenues and expenses both appear in the income statement in the same reporting period.

If we were not to use depreciation at all, then we would be forced to charge all assets to expense as soon as we buy them. This would result in large losses in the months when this transaction occurs, followed by unusually high profitability in those periods when the corresponding amount of revenue is recognized, with no offsetting expense. Thus a company that does not use depreciation will have front loaded expenses and will experience extremely variable financial results.

The purpose of depreciation is to match the cost of a productive asset, that has a useful life of more than a year, to the revenues earned by using the asset. Depreciation is an allocation process in order to achieve the matching principle. It is not a technique for determining the fair market value of an asset.

Some Causes of depreciation are -

1. Wear and Tear

2. Perishability

3. Usage Right

4. Natural Resource Usage

5. Obsolescence