Purpose of depreciation 19 / 35

Depreciation

IAS 16 PPE requires NCA to start being depreciated when they become available for normal use.

The purpose of depreciation is to spread the net cost of the assets over their estimated useful life or a number of accounting periods.

Where assets held by an enterprise have a limited useful life, it is necessary to apportion the value of an asset used in a period against the revenue it has helped to create.

Therefore, with the exception of land held on freehold or very long leasehold, every non-current asset has to be depreciated.

Depreciation reduces the net profit of an organisation, and if depreciation is not charged - then capital will not be maintained.

A charge is made in the statement of profit or loss to reflect the use that is made of the asset by the business. This charge is called depreciation.

The need to depreciate non-current assets arises from the accrual assumption.

If money is spent on an asset, then the amount must be charged against profits.

Some key terms

  • Depreciation: - the allocation of the depreciable amount of an asset over its estimated useful life.

  • Useful life: - the period over which a depreciable asset is expected to be used by the enterprise; or the number of production or similar units expected to be obtained from the asset by the enterprise.

  • Depreciable amount: - cost/revalued amount – residual value

  • Residual value: - the amount the asset is expected to be sold for at the end of its useful life. It is also known as scrap value