Read the statements carefully and choose a correct option given below :
Statement I: Depreciation must be charged so as to ascertain true profit or loss of the business.
Statement II: When market value of an asset is higher than book value, depreciation is not charged.

Question

Read the statements carefully and choose a correct option given below : 
Statement I: Depreciation must be charged so as to ascertain true profit or loss of the business. 
Statement II: When market value of an asset is higher than book value, depreciation is not charged.

Accepted Answer

The correct option is 1:
Statement I is correct because charging depreciation is a mandatory accounting practice based on the matching principle. Depreciation is the systematic allocation of a fixed asset's cost over its estimated useful life, not a method of valuation. Its purpose is to match the expense of using the asset (its decline in economic value) with the revenue that the asset helps to generate during an accounting period. By recognizing this expense, the business ensures that the calculated profit or loss truly reflects the results of the operations, which is essential for presenting a true and fair view of the financial performance. Without charging depreciation, the profit would be overstated, and the assets would be shown at an inflated value.

The incorrect option is 2:
Statement II is incorrect because depreciation is a process of cost allocation and is entirely independent of the asset’s market value. Accounting standards require the regular charge of depreciation irrespective of any market fluctuations. The mere fact that the market value of an asset is higher than its book value does not stop the depreciation process. The asset is still being consumed and losing utility over time due to usage, wear and tear, or technological obsolescence. Therefore, the expense representing this consumption must be consistently recognized as per the historical cost and matching concepts, making the claim in Statement II false.

The incorrect option is 3:
This option is invalid because, as established, Statement II is incorrect. The core accounting objective of depreciation is cost apportionment over the asset's service life, not to track or adjust to its market value. Even if the asset is appreciating in value in the market, the business is still utilizing the resource acquired at a historical cost, and that cost must be fully charged against the profits during its use. Since Statement I is correct and Statement II is incorrect, this option cannot be the answer.

The incorrect option is 4:
This option is also incorrect because Statement I is a fundamental truth in financial accounting. It is a legal and professional necessity for all businesses with depreciable assets to charge this expense. Not charging depreciation would result in an incorrect assessment of the cost of production and an inflated net profit, which is a misrepresentation of the company's financial results. As one of the statements (Statement I) is definitively correct, the option claiming both are incorrect must be dismissed.