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What is the purpose of depreciation? How does book value relate to asset worth?

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What is the purpose of depreciation? Does the book value of a fixed asset (cost minus accumulated depreciation) communicate to a user what the asset is worth? Explain why or why not. Should the financial statements reflect the value of fixed assets? Explain why or why not.

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Solution Summary

Your tutorial is 288 words and explains that depreciated historical cost is not a way to communicate "worth." The response argues that the financial statements should not report fair value and gives reasons for this position. The alternative position is mentioned. IFRS is contrasted to US GAAP as well.

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What is the purpose of depreciation?

Depreciation allocates the cost of an asset of the periods of service. That is, it spreads the costs into the periods in which it is used to match the expense with the revenue it helps to create.

Does the book value of a fixed asset (cost minus accumulated depreciation) communicate to a user what the asset is worth? Explain why or why not.

The book value of an asset is NOT intended to communicate its worth, at least in US GAAP (IFRS permits a valuation method that is not a form of depreciating historical cost). ...

Solution provided by:
Carol Sargent, PhD
Education
  • BSc, University of Virginia
  • MSc, University of Virginia
  • PhD, Georgia State University
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