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Home Depreciation, Provisions and Reserves Depreciation is Not a Matter of Valuation But a Means of Cost Allocation

Depreciation is Not a Matter of Valuation But a Means of Cost Allocation:

Most individuals at one time or another purchase and trade in an automobile. It discussion with the automobile dealer, depreciation is a consideration on two points. First how much has the old car depreciated? That is, what is the trade in value? Second, how fast will the new car depreciate? That is what will its trade in value be several years in the future? In both cases depreciation is thought of as a loss in value.

To accountants, however, depreciation is not a matter of valuation, but a means of cost allocation. Assets are not depreciated on the basis of a decline in their fair market value, but on the basis of systematic charges to expense.

Depreciation is defined as the accounting process of allocating the cost of tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.

This approach is employed because the value of the asset may fluctuate between the time the asset is purchased and the time it is sold or junked. Attempts to measure these interim value changes have not been successful because values are difficult to measure objectively. Therefore, the asset's cost is charged to depreciation expense over its estimated life, making no attempts to value the asset at fair value between acquisition and disposition. The cost allocation approach is used because a matching of costs with revenues occurs and because fluctuations in fair value are tenuous and difficult to measure.

When long-lived assets are written off, the depreciation is most often used to indicate that tangible plant assets have declined in value.

Where natural resources such as timber, gravel, oil, and coal are involved, the term depletion is employed.

The expiration of intangible assets, such as patents or good will, is called amortization.


More study material from this topic:

Definition, explanation and causes of depreciation
Depreciation is not a matter of valuation but a means of cost allocation
Activity method of depreciation
Straight line method of depreciation
Sum of the years' digits method of depreciation
Reducing balance method
Annuity method
Depreciation fund method or sinking fund method
Insurance policy method
Revaluation method
Depletion method
Machine hour rate, mileage, and global method
Methods of recording depreciation
Difference between general reserve and specific reserve
Difference between capital reserve and general reserve
Difference between reserve and reserve fund
Difference between provision and reserve



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