Question

1. Compare and contrast the dictionary meaning and the accounting meaning of depreciation.

2. In a business sense, why do you think the dictionary meaning was not appropriate for businesses to use?

3. Could depreciation be used to commit accounting fraud? What would be the benefit if a business decides to do this?

Answer 1

1. The dictionary meaning of depreciation is "to diminish in value due to wear and tear". However the meaning of depreciation in an accounting perspective is much broader, In accountancy Depreciation is the systematic allocation of depreciable amount of an asset over its useful life in accountancy.

2.The following points enumerate the reason why the dictionary meaning of depreciation is not appropriate for business use.

a. Matching concept - Contrary to the dictionary meaning, the actual purpose behind charging depreciation is to expense that portion of asset used for earning revenue. That is to record expense relating to revenue in in the same period, which is known as the matching principle

b. Useful life - Depreciation is allocated only during the assets useful life, so once an not available for use or or held for sale, depreciation cannot be allocated even when there could be wear and tear.

c.Causes of depreciation - Even though the dictionary meaning states that "wear and tear" is the sole reason, on a business perspective, depreciation could be caused by number of factors such as perishability, inefficiency, obsolesene, wear and tear etc.

d. Land - Land has unlimited useful life, so depreciation is not charged on land. However if we were to follow the dictionary meaning, depreciation should be charged to land as there could be wear and tear.

3. Depreciation is a non cash expenditure, it is usually calculated in house based on depreciable value and useful life of asset. This is the same reason depreciation can easily be used to commit accounting frauds. For instance a business can extend the useful life of asset, delaying recognition of depreciation , thereby increasing profit during the period. The vice versa is also possible to reduce profit and save tax. Another possible scenario is to charge depreciation even when asset is not available for use thus reducing profit and saving tax.