Depreciation means loss on account of use of an asset or decrease in its value on account of passage of time or decrease in its efficiency because of its usage in monetary terms, Depreciation is a loss to the business. So unless it is considered like other expenses and losses, true profit/loss cannot be ascertained. In other words, depreciation must be considered in order to find out true profit/loss of a business. As we know, assets are used up gradually in a business for a number of years. Each year, a portion of the usefulness of these assets expires and this portion of their total cost should be recognized as an expense. Failure to record depreciation would result in understating total expenses of the period and consequently overstating the net profit.
For example suppose a machine is bought for Rs. 50,000. Its value must diminish gradually on account of use — the more it is used, the more will it diminish in value. After sometimes it will become unfit for use. Then a new machine is to be bought. Suppose the estimated life of machine is 20 years. In that case the annual loss on account of depreciation will be Rs. 2,500 (50,000 + 20). It must be debited to Profit and Loss A/c; otherwise the true result cannot be obtained and the Balance Sheet will not disclose the true financial position of the business.
Similarly, depreciation must be taken into account in respect of all other assets like building, furniture, office equipment etc.
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