Question

Describe the nature of depreciation as it is used in accounting. In your response, discuss what depreciation IS and what it IS NOT, from an accounting perspective.

Answer 1

Depreciation is the recognition of a loss in value of a plant asset due to wear and tear over time. The matching principle states that all costs that were incurred to generate the revenue appearing on a given period’s income statement should appear as an expense on the same income statement.

A method used to implement the matching principle is systematic and rational allocation. Many costs cannot be directly linked to specific revenue transactions. They can, however, be tied to a span of years and allocated as an expense to each of those years. Depreciation as used in accrual-based accounting is an example of this method:

Sales equipment (i.e.: Furnitures/fixtures) is essential to generate revenue. However, linking the cost of each display case, piece of furniture, and the like to specific sales transactions is difficult. Instead, the equipment’s cost is systematically allocated as “depreciation expense” to the years during which the equipment helps generate revenue.

Depreciation is an expense which is part of profit and loss and the depreciation cannot be done on land.