Depreciation is the estimated money value of the reduction in working capacity or in the intrinsic value of an asset due to either use of the asset or due to mere efflux of time. It is allocated by charging a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset. In other words, the allocation of the depreciable amount of an asset over its estimated useful life is depreciation. However, one thought is that, depreciation is source of fund. Lets discuss the thought.
Arguments in favour
- Depreciation is deducted from revenue to ascertain the profit. Hence a part of revenue in form of depreciation lies in the business and increases its working capital. Depreciation increases working capital of the concern expends, thus depreciation is a fund.
- As sale of any asset or its part is treated as source of fund. Depreciation (a part of fixed assets) is included in sale price thus it is also treated as fund.
- Depreciation realises cost of fixed assets. As depreciation is included in cost of production, which increases the sale price, this in its turn increases the revenue. Such revenue increases the current assets of the business. Therefore, depreciation converts fixed assets into current assets and is a fund.
- Depreciation provides major source of fund in Fund Flow Statement. Fund from operation is obtained by adding depreciation to net profit.
- Money invested in the business goes out and flows back for generating income. Whereas, sources of fund are money, which comes from outside the business and increase its worth. Depreciation is mere recovery of money invested in the business and is not an addition to the business’ worth. Hence, it is not a source of fund.
- Depreciation is not a process of generating revenue but a process of allocation of capital cost invested in the fixed assets. It is a mere circulation of money from fixed assets to current assets. Hence, it is not a source of fund.
- Depreciation (as an expense) is charged, even no sale occurs during the period. Hence, depreciation itself does not generate fund.
- Depreciation is added with profit from operation in Fund Flow Statement because it has been deducted to calculate the net profit. So, it cannot be treated as source of fund.
- A layman always tries to increase his fund. If depreciation is a source, then he can charge depreciation at higher rate to generate more fund but it is not practised as depreciation is not a source of fund.
In spite of various arguments to treat depreciation as source of fund, it cannot be absolutely termed as source of fund. Depreciation is a technique through which fund is not created but only maintained.
However, depreciation may influence, indirectly, the fund position of the concern. For instance, depreciation reduces tax liability and saves outflow of fund. Also share your views.