Importance of Depreciation for Business Accounting: Understanding Income Statements & Balance Sheet

Running head: INCOME STATEMENTS & BALANCE SHEET
Income statements & balance sheet
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1INCOME STATEMENTS & BALANCE SHEET
Reason why a business has to provide for depreciation when drawing up their account
As per ‘IAS 16 Property, Plant and Equipment’, the term depreciation is considered
as systematic distribution of depreciable value of any asset over the useful life of the asset.
Here, the depreciable value is cost of the asset or any other amount that is replaced for cost
reduced by the residual value. Depreciable amount of any asset must be assigned on
systematic approach throughout the useful life of the asset. Depreciation is recorded even if
asset’s fair value is more than the asset’s carrying value and shall be recorded as long as the
residual value of the asset does not exceed the carrying value (Bragg 2017). Depreciation on
asset starts when the asset becomes available for use that is when the asset is in the condition
and location required for it to be capable of operating by the management for the intended
purpose. Depreciation ceases on the date when the asset classified as held for sale or the asset
is derecognised, whichever is earlier. Useful life of asset is characterized in terms of the
asset’s expected utility to the organisation. The entity’s asset management policy of the
company generally involves disposal of the asset after specific time or after consuming
specific portion of future economic benefit associated with the asset (Del Giudice,
Manganelli and De Paola 2016).
Property, Plant and Equipment or any other fixed asset shall be regularly revalued to
assure that the asset is recorded at the appropriate amount in the financial statement.
Depreciation is essential for the fixed asset as it loses its residual value owing to normal wear
and tear, depletion, passage of time or accidents over the period of time. Hence, the asset’s
actual value cannot be established if purchase cost of the asset is recorded in each year. Fixed
assets are considered as company’s major expenses and have set of the life period when they
are commercially used. Hence, after certain period they become obsolete for use and hence
require buying the particular asset again (Bozzolan, Laghi and Mattei 2016). With regard to
lessen burden on the business accounting establishments from all round the globe,
depreciation tool is used for determining the asset’s actual value and using it as sinking fund
for replacing the asset in future. The entire procedure of depreciation computation takes place
at the closing of year while the accounts are prepared. It is a non-cash expense and reported
under both profit and loss account as well as balance sheet. In balance sheet it is reported in
asset side for reflecting the reduction in the value of capital asset at one time point and is
expressed as accumulated depreciation. On the other hand, under the income statement the
depreciation amount expensed is recorded under other expenses of the business. Depreciation
expenses for the current period are added with the previous year’s depreciation amount to