why do we record depreciation in accounting
The purpose of is to charge to a portion of an that relates to the generated by that asset. This is called the, where revenues and expenses both appear in the
in the same, which gives the best view of how well a company has performed in a given reporting period. The trouble with this matching concept is that there is only a tenuous connection between the generation of revenue and a specific asset. Under the tenets of analysis, all of the assets of a company should be treated as a single system that generates a profit; thus, there is no way to link a specific fixed asset to specific revenue. To get around this linkage problem, we assume a steady rate of depreciation over the of each asset, so that we approximate a linkage between the recognition of revenues and expenses over time. This approximation threatens our credulity even more when a company uses, since the main reason for using it is to defer the payment of taxes (and not to better match revenues and expenses).
Also, the matching principle does not work in those cases where depreciation expense is recognized but there are no sales, as occurs in seasonal sales situations. The type of depreciation that most closely links the creation of revenue to asset usage is the, which charges natural resources to expense as they are extracted. However, this option is not available for most types of. Under no circumstances should we consider depreciation to be an approximation of a decline in an asset's, since fair value can increase or decrease over time and is related to supply and demand, rather than usage. If we were not to use depreciation at all, then we would be forced to charge all assets to expense as soon as we buy them. This would result in large losses in the months when this transaction occurs, followed by unusually high in those periods when the corresponding amount of revenue is recognized, with no offsetting expense.
Thus, a company that does not use depreciation will have front-loaded expenses, and will experience extremely variable financial results. The typical to record depreciation is a debit to depreciation expense (which appears on the income statement) and a credit to (which appears as a in the balance sheet). Related Courses Accounting is responsible for capturing all types of transactions in a company. Depreciation is an expense that relates to a companyвs fixed assets. It is important because depreciation expense represents the use of assets each accounting period. Many different types of assets can incur depreciation. Facilities, vehicles and equipment are among the most common assets depreciated. Depreciation represents the specific use of a companyвs assets in an accounting period.
When companies make large purchases, they will record the items as assets. Assets represent long-term value for a companyвs facilities, vehicles and equipment. Expensing these items when purchased would create distorted net income. Therefore, accounting principles prefer that these items be recorded as assets with a corresponding expense recorded when the company uses each item. Many different depreciation methods are available for use in accounting. Basic elements for these items include historical cost, salvage value and useful life. Companies will often subtract the salvage value в the money gained when selling the asset в from the historical cost. Using the straight-line depreciation method, accountants divide this figure by the assetвs useful life. This represents the annual expense for using the asset. Companies use depreciation to report asset use to stakeholders.
Deprecation also reduces the historical value of assets. Stakeholders can review this information and know when to expect replacement assets purchased by a company. For example, a company with production equipment will often replace these items at some time during its operations. When accumulated depreciation nears the assetвs historical cost, a replacement purchase may be coming up soon. Tax benefits are also possible with depreciation. Although depreciation represents a non-cash expense on the income statement, it does reduce a companyвs net income. Lower net income will incur a smaller tax liability. To maximize this benefit, companies will often use an accelerated depreciation method. The Internal Revenue Service provides companies with an accelerated depreciation method for different asset classes. This allows for more depreciation early on with assets and lower initial tax liabilities.
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