What is the purpose of depreciation in financial management?

The purpose of depreciation in financial management is to allocate the cost of a tangible asset over its useful life. This systematic allocation reflects how much of the asset's value has been used up during a specific period. In accounting terms, depreciation allows businesses to match the cost of the asset with the revenue it generates over time, ensuring that financial statements accurately represent the company's financial position.

By spreading the cost of the asset over its useful life, depreciation provides a more accurate picture of an organization's profitability and reduces the tax burden because the depreciation expense is tax-deductible. This practice helps in budgeting and financial planning, as it takes into account the gradual loss of value of assets due to usage, wear and tear, or obsolescence.

Overall, recognizing depreciation is essential for reflecting the true economic reality of businesses and ensuring compliance with accounting standards.