Question

Which of the following statements about depreciation is correct?

a.Each year the accountant adds an amount for depreciation when calculating the company’s profit.
b.The annual depreciation charge measures the cash that the company has spent on maintaining and renewing its plant and equipment.
c.To calculate the cash produced by the business, it is necessary to deduct the depreciation charge from accounting profits.
d.To calculate the cash produced by the business, it is necessary to add the depreciation charge back to accounting profits.

Answer 1

The correct statement about depreciation is that to calculate cash produced by the business, it is necessary to add the depreciation charge back to accounting profits.

Step-by-step explanation:

When understanding depreciation, it is crucial to know it is an accounting concept that represents the allocation of the cost of physical assets over their useful lives. Depreciation is not a measure of cash spent, but rather an approximation of the reduction in value of those assets as they are used in the business. Therefore, the correct statement about depreciation is: d. To calculate the cash produced by the business, it is necessary to add the depreciation charge back to accounting profits. This adjustment is important for cash flow calculations because depreciation is a non-cash expense that has already been deducted from accounting profits.