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Depreciation refers to the reduction in the value of a fixed tangible asset due to its use, wear and tear, efflux of time, or obsolescence. In simple terms, it is the systematic allocation of the cost of a tangible asset over its useful life. Depreciation is charged to account for the loss in value of an asset as it is used in the process of generating revenue. It is a non-cash expense and does not involve any outflow of cash but is charged to the profit and loss account to reflect a more accurate profit figure. Depreciation occurs due to various reasons such as normal wear and tear, passage of time, obsolescence due to technological advancements, and depletion in case of natural resources. It is a part of the matching principle in accounting, which ensures that the cost of using an asset is matched with the revenue earned from that asset during a given period. The need for depreciation arises due to several reasons. First, it ensures that the true and fair view of the financial statements is presented. By charging depreciation, the actual value of the assets is shown in the balance sheet, preventing overstatement of the asset’s value. Secondly, it ensures compliance with the matching principle. Revenue generated from using an asset must be matched with the cost of using the asset, which is achieved by charging depreciation. Third, depreciation helps in tax computation. Depreciation is allowed as a deductible expense under income tax laws, which reduces the tax liability of the business. Fourth, depreciation ensures sufficient provision for replacement. Over time, as assets wear out _________ ________ ________ _____ ______ ________ _______ _____ ____ _________ _____ ____.
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