Financial Accounting

Myth about depreciation

It is most important to realise that the depreciation concept is not designed to provide a means or method to replace ageing assets. Depreciation is not intended to be a ‘savings-scheme’ by which the company can fund purchases of new assets. Many non-accountants believe that depreciation creates a fund which will provide for the purchase of new investment in the future.

On the contrary, the purpose of depreciation is to maintain the original capital base of the company by acting as a constraint on the amount of profits available for distribution as dividends. If a business is concerned about replacing its existing fixed assets in the future, it will need to set aside some of its current profits in order to fund future asset purchases.

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