UGM June 2019 Q83
- Option : D
- Explanation : Depreciation refers to the decrease in the value of assets, particularly, fixed assets, which may lose their values due to wear and tear, obsolescence, the passage of time, exhaustion, and accident. As this loss in value (depreciation) arises out of operations of fixed assets in the business, it is treated as an operating expense to Profit and Loss Account. The usual treatment of depreciation in the final account is to debit the same to Profit and Loss Account and credit the concerned Fixed Asset account (i.e. deducted from fixed assets in Balance Sheet). Since Profit and Loss
Account and Fixed Asset account are noncurrent accounts, depreciation is treated as a non-fund item while preparing the fund's flow
statement. In other words, depreciation is added back to operating profit to find out funds from operations since it does not affect the flow of funds. Hence, it is neither a source nor an application of funds. If depreciation were really a source of funds by itself, then any business could improve its funds position by providing a periodical depreciation charge. However, depreciation can be taken as a source of funds in a limited sense because of there reasons:
(i) Depreciation finds its way into current assets through the charging of overheads (including depreciation). The value of closing inventory may include depreciation of fixed assets as an element of cost.
(ii) Depreciation does not generate funds but it definitely saves funds. For example, if the business had taken the fixed assets on hire, it would have been required to pay rent for them. Since it owns fixed assets, it saves outflow of funds which would have otherwise gone out in the form of rent.
