Question

Evaluate the advantages and disadvantages of depreciation as an accouting concept- on balance do you think the measurement of depreciation aids accounting practice?

Answer 1

When a company purchases a fixed asset, it is required to capitalize the asset in its financial records. A fixed asset is a huge, physical asset that the company plans to use for in the business operation for several years. The total cost of this asset is determined by the company by adding all the costs needed for the purchase the asset, including purchase price, freight costs and legal fees. The company expenses certain portion of the total cost each year by the way of depreciation. The advantages and disadvantages of depreciation are as follows:

Advantages:

1) Ascertainment of true profits: When company purchases an asset it is making a payment in advance for the use of asset. Depreciation refers to the cost of using the fixed asset. To know the correct and true amount of profit or loss, depreciation need to be treated as revenue expenses and debited to profit and loss account.

2) Replacement of assets: Assets used in the company are required to be replaced after the expiry of their useful life. The depreciation charges help in accumulating funds for the asset's replacement.

3) Saving in taxes: Depreciation charges on assets save the tax amount equivalent to tax rate, thus business need not to pay excess income tax to the government

4) Reporting of true and fair financial position of a business: The asset will appear in the balance sheet at the original value if the depreciation is not provided. Thus to depict the true financial position of a business, depreciation is needed to be charged on the assets.

Disadvantages:

1) Difficult to Replace Assets: It is not possible to replace the asset with the provision of depreciation as it is charged on the historical cost of the asset

2) Determination of Life: The depreciation is computed taking into account the asset's esti­mated life. Determination of estimated life is difficult to ascertain and in case the asset is not used up to its estimated life, the cost recovery will be impossible

3) Depreciation is regarded as a clear preference because permits businesses to deduct expenses quicker than assets actually wear out

4) Lower future deduction can be a concern for growing businesses because it does not create big tax deductions, with larger upfront deductions coming at the expense of lower deductions in the future

Yes, in my opinion the measurement of depreciation aids accounting practice. It acts as a source of internal financing that does not impact the working capital of the concern because does not involve outflow of any cash like other expenses; and it represents the usage of assets each accounting period