Depreciation is a process of allocation and not valuation. What do you think is meant by this statement? Give examples to support your answer.
Chalmers and oliver (2014, p.213) describes ‘depreciation as an allocation or what it is now called amortisation of the depreciable amount of a depreciable asset over its estimated useful life'. The nature of depreciation and amortisation is same because they both the expenses incurred in the income statement which further do not involve any outflow of cash as such. (Rama Rao 2010) further contribute to the statement of depreciation being an allocation process as it caters to spreading the cost of a fixed asset over its useful life less salvage value. So, a portion of that cost is recognised as an expense in each period that the asset is in service. For example:
A piece of machinery cost $ 11,000 with a serviceable life of 5 years.
The scrap value of the machine at the end 5th year is going to be $1,000 not $10,000 (i.e. $11,000 less $1,000) will be allocated over 5 years on rational basis.
(Accounting allocation 2011) fair value or valuation on the other hand, reflects the overall value of the remaining equipment, machinery etc., which is expected to be consumed by next 12 recognised months or so on. The net book value may not represent the actual market value of the asset. Many authors claimed that this approach is employed because the value/valuation of asset may fluctuate due to the time span when that has been purchased and the time it is sold. Also, values are difficult to measure where the allocation of price is rather straightforward. However, it is not a matter of valuation but a means of allocating the cost.