Question

discuss depreciation in the context of the various accounting concepts

Answer 1

Solution :

First let us know what is depreciation :

Depreciation from accounting point is known allocation of cost of asset over its useful life. Depreciation expense affects the value of business in the form of assets because the accumulated depreciation on balance sheet tend to reduce the book value of assets. It also affects the net income of an entity. Therefore from Accounting point of view depreciation is not only a expense but also a relevant deduction to net income from various accounting concepts point of view.

Depreciation and accounting concepts :

Since depreciation is an expense, it is deducted from the net income for the period in which asset was used. When a expense is matched with the period in which the income is generated , in which the expense is related to generation of income than these terminology is called as matching concept. In the same way we can relate the matching concept with depreciation terms. Depreciation is calculated for the asset used for that period to generate income for the business. So if the asset generating income is belonging to the period of reporting than the expense related to the generation of that income also will belong to that same period of reporting. Hence depreciation is reported accordingly.

Depreciation is also an effect of an accounting concept , accrual accounting which most of the business follows. According to the accrual concept , business must recognize and report earnings when they are earned and expenses when they are incurred regardless of the effect of cash involved in it. Therefore depreciation is a non cash expense as it reduces the value of asset without any actual cash outflow . Therefore accrual concept encourages non cash expense and earnings to be reported even if there is no actual cash inflow or outflow seen.

One of the major important concept of business , which forms the base of a business's ongoing life is called as going concern concept. As per this concept the business is seen to be continuing in the foreseeable future with out any interruption and there is no closure expected for the business.

A company is a going concern if no evidence is available to believe that it will or will have to cease its operations in foreseeable future.

Computation of depreciation is one of the examples of going concern concept. Depreciation is calculated on the estimated economic life of an asset rather the current market value of it. Companies assume that their business will continue for an indefinite period of time and the assets will be used in the business until fully depreciated.

In this way depreciation is a result of many accounting concepts.