Accountancy · Ch 7 — Depreciation, Provisions and Reserves
True and Fair Financial Position
True and Fair Financial Position
Why Depreciation Is Necessary for a True and Fair View
A balance sheet is meant to show what a business owns (assets) and what it owes (liabilities) on a particular date. If an asset like a machine or a building is simply shown at its original purchase price year after year, that figure becomes misleading. The asset has been used up — it has lost value through wear and tear, passage of time, or obsolescence. Showing it at its old cost overstates its worth.
The result is a balance sheet that does not reflect the real financial position of the business. An outsider reading such a balance sheet would think the business has more resources than it actually does. This is not just poor practice; it violates established accounting principles and, in many cases, specific legal requirements.
The Accounting Treatment
To avoid this, depreciation must be charged every year. The journal entry is:
| Date | Particulars | L.F. | Debit (₹) | Credit (₹) |
|---|---|---|---|---|
| Depreciation A/c ………Dr. | ||||
| To Asset A/c | ||||
| (Being depreciation charged on the asset) |
Depreciation is an expense. It is debited to the Depreciation account (which is later transferred to the Profit & Loss account). The asset account is credited, which reduces its book value. Over time, the asset's carrying amount in the balance sheet falls, reflecting its true worth.
Without depreciation, assets remain overvalued on the balance sheet. The balance sheet then fails to show a true and fair financial position — a requirement of both accounting standards and company law.
What Happens If Depreciation Is Omitted
- The asset appears at an inflated value. …