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Depreciation as a Source of Fund (For and Against Arguments)
(a) Depreciation is an expense as expired cost which is recovered in cash as the same is included with the cost of production. For this, it is quite logical that if sale of fixed asset is treated as a source of fund, why not depreciation.
(b) When we ascertain ‘Trading Profit (Adjusted)’ or Funds from operation, the amount of depreciation is added back to net profit. The amount of depreciation should not be added to ‘funds from operation’ if the same is not considered as source.
(c) Funds normally mean (net) Working Capital. As such, amount received by way of profit and depreciation increase the amount of Working Capital although the respective figure cannot be ascertained. Thus, amount earned from net profit may be treated as a source so also the amount of depreciation.
(d) There is no doubt about it that depreciation constitutes a major source of fund or inflow of fund for which depreciation pays a very significant role for financing the funds of a firm.
(e) For ascertaining net profit, the amount of depreciation is deducted and consequently the resultant amount reduces. Now if that amount of net profit is distributed among the shareholders by way of dividend, the real figure of dividend is reduced by the amount of depreciation which remains in the firm and represents as a source of fund.
(f) Depreciation is charged against revenue the object of which is to create a fund. It is not like other expenses (say Salary, Wages etc.) which are paid in cash i.e. for the amount of depreciation capital fund is not reduced. So, it (depreciation) can be treated as a source.
(a) Practically, sale of fixed assets cannot be treated as a source of fund. On the contrary it is recovery of fund. Because selling price of a fixed assets include profit/loss and recovery of invested fund. Only profit on sale of fixed assets may be treated as a source and the rest is treated as a recovery of capital. Thus, depreciation cannot be treated as a source of fund.
(b) Depreciation is an expired cost like other direct or indirect expenses. Thus, if depreciation is considered as a source of fund, then all other direct/indirect expenses should also be treated as sources of fund—which is not possible.
(c) While calculating funds from operation, depreciation is added back to profit as non-cash expense for which there is no outflow of funds like other expenses. Sources of fund are deflated by non-cash items as they are deducted from sales revenue.
When an asset is acquired there is outflow of funds, but, in the subsequent years, when the asset is allocated over its useful life, no inflow or outflow of fund occurs, i.e. no cash transaction happened. Thus, depreciation should not be treated as a source.
(d) If depreciation is considered as a source of fund, in case of need of funds, funds may be provided by charging depreciation at a higher rate so that the management can avoid the trouble of issuing shares, debentures etc. for procuring funds—which is practically impossible.
e) Even if there is no sale or no profit, the amount of depreciation must be provided for in the books of accounts. Then, how can depreciation be treated as a source?
(f) Sources of funds arise from outside or external sources of the business. Since depreciation is an internal amount, the same cannot be treated as a source which comes from outside or external sources of the business. So, depreciation can never be treated as a source of fund.
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