Final answer:
Depreciation allocates the cost of a tangible asset over its useful life, ensuring financial statements reflect true asset values and expenses in relevant periods. It keeps the Income Statement and Balance Sheet relevant by matching expenses with generated revenues and maintains accurate asset valuations.
Step-by-step explanation:
Depreciation is a method used to allocate the cost of a tangible asset over its useful life. In financial reporting, depreciation is critical as it ensures the relevance of financial statements, including the Income Statement and Balance Sheet. By consistently depreciating an asset, the Income Statement reflects a portion of the expense of the asset over the period it is used, which aligns with the matching principle in accounting. This principle states that expenses should be recorded in the same period as the revenues they help to generate, which promotes more accurate profit calculation. On the Balance Sheet, depreciation affects the carrying value of an asset, thus keeping the reported value of the company's assets in line with their economic value. Without depreciation, the assets could be overvalued on the Balance Sheet and the Income Statement would not depict the true cost of asset usage, leading to misleading financial reports. Therefore, depreciation is vital for maintaining the accuracy and usability of financial information for stakeholders.