Depreciation
Depreciation
Depreciation is a provision made against the normal wear and tear of the
physical assets of an entity, duly taking into account the anticipated life time
of each asset reflected in the books of account. The accumulated depreciation
will also take care of the replacement cost of the physical assets, as and when
necessary.
Banks must check the opening balance and closing balance of accumulated
depreciation and cross check it with the figure shown under depreciation
for the current year in the Profit & Loss Account. Since depreciation is a
non-cash outflow, most of the people do not takes it seriously. It is not
given the extent of importance it deserves. Though depreciation is a non-
cash outflow, it has got its own relevance and importance while studying the
financial health of a commercial entity. Depreciation affects profitability,
distribution of profits in the form of dividends etc. and retained
earnings. As a result, the net worth of the unit is also affected.
importance and implications of providing for the right amount of depreciation.
Banks must also check the opening balance and closing balance of
accumulated depreciation and cross check it with the figure shown under
depreciation for the current year in the Profit & Loss Account.
There is a myth and misconception even among the educated people and
many financial analysts/managers that a company which has a track record
of giving consistently good dividend for many years in a row is financially
sound and well managed. To create this kind of wrong impression, no
provision or lower provision for depreciation helps.
Lower depreciation leads to artificially boosted up profitability. This
necessitates payment of higher taxes than what is necessary. Hence, tax
authorities also do not bother much in case of lower provisioning made
under the head Depreciation, by the individuals or institutions concerned.
The reasons adduced by a borrower for not providing for required amount
of depreciation must be fair and convincing. Else, the bankers may at their
discretion recalculate the correct amount of applicable depreciation and
then recast the entire set of financial statements to ascertain the true state
of affairs of the unit.