Question

In accounting we "capitalize" long-lived assets by putting them on the balance sheet and then depreciating those assets over time, based on some concept that each year the asset represents less value to the business and that each year a certain amount of the value of the asset is used up in the business processes. For accountants, it would be much easier just to expense long-lived assets at the time of purchase. Even though it requires more work, what are the benefits (and to whom) of the methods we use for accounting for long-lived assets?

Answer 1

As per the rules of accounting and guidelines of Accounting standard board, the long lived assets or usually known as fixed assets in a company's balance sheet should be depreciated at a certain rate every year. The benefits of such treatment of long lived assets are plenty to both users of financial statements and to the management as well. If a long lived asset is shown as an expense in the year of purchase it will distort the income statement of the company very much and the profits shown will be very less which will result in misunderstanding among the users about the operational efficiency of the company. The users will also not get a fair view of the company's financial position in the longer run. However, if the same is capitalized and is depreciated over the years, it will be easy for management to charge a particular amount in the income statement every year as depreciation and the users of financial statements will also get to know the exact financial position of the company in an effective way. The management of the company can also claim deduction of depreciation every year from the income tax, allowing it to pay lower taxes and thus higher profits for the shareholders. Methods like Straight line and WDV is used by companies normally for depreciating its fixed long lived assets. Under both methods a specific amount is charged every year as depreciation in the income statement for the life of asset.