Question 1

Is depreciation just the money a business sets aside to buy a new asset?

Accepted Answer

No, this is a common misconception. Depreciation is a non-cash expense that spreads the cost of an existing asset over its useful life. It reduces profit but does not involve setting cash aside. A business must manage its cash flow separately to ensure it has funds available to replace assets when needed. Depreciation is an accounting entry, not a savings fund.

Question 2

Does the Net Book Value (NBV) of an asset equal its resale or market value?

Accepted Answer

Not necessarily, and often not at all. NBV is a calculated accounting value (Historic Cost - Accumulated Depreciation). Market value is what someone is willing to pay for the asset. An asset could have an NBV of £10,000 but a market value of £15,000 due to high demand, or only £5,000 if it's technologically outdated. The purpose of NBV is cost allocation, not market valuation.

Question 3

If a business wants to report higher profits, can it just decide not to charge depreciation for a year?

Accepted Answer

No, this would violate accounting principles and standards. The 'consistency' principle requires a business to apply the same accounting methods from one period to the next. The 'matching' principle requires costs to be matched to revenues. Deliberately omitting depreciation would overstate profits and asset values, failing to provide a 'true and fair view' and could be considered fraudulent.

Depreciation

What you need to know

Depreciation