Why do we depreciate assets?
In accounting, we have a principle called the principle of income realization.
According to this principle, we should recognize (or in other words record) all incomes when they are realized.
In accounting standards and books, an income is assumed to be realized when:
A- The relevant cash has been received or there is a possibility of receiving and
B- All the necessary work has been done to finalize the income.
For the above 2 reasons, we have pre-registration. It means that we are not allowed to recognize income when we received money and the work was not done (that is, condition B was not met). Also, when the goods are sold and you are sure that you will not receive cash, you are not allowed to recognize the income (that is, condition A is not met).
In accounting, we also have another principle called the principle of cost matching with income.
According to this principle, all the expenses that correspond to the recognized income according to the realization of the income must be identified and documented.
Example:
A product is purchased for 100 Rials:
1- If this product is not sold until the end of the year, then the amount of 100 Rials will be shown in the balance sheet as the product balance at the end of the period. Why don’t we convert the purchase of goods into an expense? Because there is no income (realization of income), it means that we did not sell the product and therefore there is no cost (matching cost with income).
2- If the same product is sold for 120 Rials, then because the income has been realized, the amount of 120 Rials is recognized as income and the amount of 100 Rials is recognized as expenses.
3- If the same product is broken and destroyed upon receipt, the initial amount of 100 Rials will be converted into a loss and recognized. In this case, because the income is not recognized, the cost is not recognized and the loss account is used instead of the cost.
We depreciate the assets or do not convert the entire assets to cost at the time of purchase because:
We use assets to earn benefits. Due to obtaining the benefits of the assets during the year, income realization occurred (principle of income realization) and therefore the related costs should also be identified (principle of matching cost with income). These costs are exactly the same as depreciation cost.
tip:
Of course, the above does not apply to land because, in addition to accounting principles, the asset must be destroyed over time, and since the land is not destroyed, we do not depreciate it.
Mehdi Koh Soltani (financial services, accounting, financial and tax consultant):
Group of accountants, auditors, Tabriz
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