Depreciation — common mistakes

In exam questions, be precise. State that depreciation is an expense on the Income Statement which reduces net profit, and that it reduces the Net Book Value of non-current assets on the Statement of Financial Position. Avoid vague statements like 'it affects profit' or 'it lowers the asset's value'.

If asked effect on profit of changing useful life: longer life → lower annual charge → higher profit (all else equal). State this clearly in evaluate questions.

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.

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could have an NBV of £10,000 but a market value of £15,000 due to high demand, or only £5,000 if it's technologically outdated.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.

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.