Depreciation of Fixed Assets
Fixed assets must be revalued regularly to ensure that the right cost is included in the accounting books. Depreciation is very much necessary for fixed assets because the fixed asset would lose its residual value due to the wear and tear, depletion, passage of time, obsolescence or accidents over a time period. Therefore, the actual value of the asset cannot be determined if we take the purchase amount in the books every year.
Fixed assets are major expenses of any business and have a set life period of their own when used commercially. After a certain time period they become obsolete for use, and require the business to buy that particular asset again.
In terms of realization of cash, fixed assets have a longer liquidity time period. For example, if the business has purchased land and buildings, it will take a longer time to be realized in cash. In contrast, the current assets of the company – including money receivable, inventory, etc. – have a shorter time frame to be realized in cash.
In order to reduce the burden on the business accounting bodies all over the world, the depreciation tool is used to determine the actual value of the asset and use it as a sinking fund to replace the asset in the future.
The whole process of depreciation calculation occurs at the end of the year when accounts are prepared. The calculation is a non-cash expense which is estimated or forecasted and is shown in both the profit and loss statement and the balance sheet.