DEPRECIATION - A SOURCE OF FUND OR NOT

DEPRECIATION – A SOURCE OF FUND OR NOT

v  Arguments in favour of considering it as a source of fund

1.      Depreciation is considered as an expired cost. It is included within cost of goods sold. It is an allocated cost which is realised when goods / assets are sold. If sale of an asset is considered as a source of fund, depreciation should also be treated as a source of fund.

2.      When fund from operations is found out, depreciation is added back with that.

3.      Depreciation does not cause any outflow of cash. Naturally, current assets increase; the working capital also increases. If working capital is considered as a fund, depreciation causes its addition. So, it is a source of fund.

v  Arguments in favour of not considering depreciation as a source of fund

1.      Depreciation is an expense. No other expense is considered as a source of fund. So, it cannot be the solitary exception.

2.      Depreciation may be considered as a recovery of capital cost allocated over years. If depreciation is deemed to flow back into the business that cannot cause any inflow of cash. As such, it is never a source of fund.

3.      It is added back with fund from operations because the profits taken there are calculated after deducting depreciation. The subsequent addition compensates for the deduction already made. It is an internal adjustment which does not enhance ‘fund’.

4.      A concern suffering from paucity of fund cannot solve that by charging more depreciation. It cannot establish itself as a source of fund.

5.      There may be no sale or no profit in a year. Still depreciation has to be matched. In that year it cannot be said that fund has been generated through depreciation.

6.      Even if there is a sale of any depreciable asset, that cannot be technically considered as a source of fund. It is the amount recovered against capital outlay. So, depreciation is a tool in the process of recovery of capital.

Conclusion: Depreciation is a process of allocation of cost. It cannot be a source of fund. At best by charging adequate depreciation, the taxable profit may be legally reduced. The tax burden may be reduced. It may help to conserve working capital. It may indirectly regulate the fund position but cannot increase funds.