Another misconception is that the purpose of depreciation is to set aside funds for replacement of asset at the end of its serviceable life. This view is also unfounded because of the following reasons:

(i)    Funds for replacement of assets depend on the existence of surplus of funds inflows over outflow. No amount of depreciation will provide funds for replacement if the company cannot meet its current cash operating costs from the current revenues. In other words, the amount of cash on hand any time is the difference between total receipts and total disbursements.

(ii)    Depreciation charges are not related the replacement of asset which continues to be depreciated even when no intention to replace it is. The acquisition of new asset creates a new series of depreciation charges.

(iii)    It might be possible to segregate cash equivalent to the accumulated depreciation. Such funds would yield greater returns when used in the regular operation of the business. Moreover such funds could be used to acquire new asset. This would be possible under stable prices.

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