Q.Explain briefly why a business needs to provide depreciation on its fixed assets, giving at least three distinct reasons.

Depreciation is provided mainly to show the true profit for the period, to present fixed assets at a fair value in the Balance Sheet, and to build up funds toward eventually replacing the asset.

1. To ascertain the true profit or loss of the business. Using a fixed asset to earn revenue genuinely uses up part of its value every year; if that cost is not recognised as an expense, the reported profit would be systematically overstated, giving a misleading picture of how the business actually performed.

2. To present a true and fair value of fixed assets in the Balance Sheet. Fixed assets are shown net of accumulated depreciation precisely so that the Balance Sheet reflects what the asset is genuinely still worth to the business, rather than continuing to show its full original cost year after year regardless of age or use.

3. To accumulate funds toward eventual replacement. Depreciation is a non-cash charge, but by reducing the profit available for distribution as dividends each year, it effectively retains cash inside the business that can be used, when the time comes, to replace the worn-out or obsolete asset.

4. To arrive at the correct cost of production or services. Where a fixed asset is used directly in manufacturing or providing a service, its depreciation is a genuine cost of that production, and omitting it would understate the true cost of what the business makes or sells. …

Students sometimes state only a single reason (usually 'to show the correct value of the asset') and stop there — examiners typically expect at least two or three distinct reasons, spanning bot …