Since Depreciation is considered as a non-cash expenses. Then why it is included in income statement? Explain

Answer 1

Depreciation is the process of allocation the cost of an asset over its estimated useful life. The amount of depreciation depends on the depreciation method chosen by the company and how it is expected to be used.

For example, two companies may purchase the identical asset, e.g., a truck. One company uses it for cross-country deliveries and runs the truck 24 hours, 7 days a week, so it expects this asset to last 4 years. Another company buys the same truck and only uses it for local deliveries 5 days a week. It expects that this asset to last at least 7 to 8 years.

Generally Accepted Accounting Principles (GAAP) requires the use of the matching principle which states that expenses should be matched to revenue in the period is which it is generated. Also financial statements are prepared on an Accrual basis, which requires that expenses be recorded when incurred, and revenue when obligation to deliver products or services are fulfilled, NOT when cash is received or paid.

Answer 2

Depreciation expense is an accounting measure that reduces net income for the proportional cost of asset allocated on the income statement. The company earn revenue from the use of the asset and pays for it over the time it is used (the life of the asset) by charging the cost to the income statement. As a result, the amount of depreciation expensed reduces the net income of a company.

It is a non-cash expense because the cash transaction happened at the time of the asset purchase. Basically the company paid for the asset upfront.