Depreciation and Replacement Cost

The sharp rise in prices in the last few years has stirred up a brisk debate on the meaning and measurement of business income. In computing income, the costs of labor and material are generally reflected in current prices, but the provision made for depreciation is generally not sufficient to replace the fixed assets. Accountants try to meet the depreciation shortfall by speeding up the normal process of writing off the original asset cost. Does it solve the problem? In this paper, we have investigated the various approaches to the problem of providing sufficient depreciation allowance in measuring income. The relationship between written down value and the straight-line inflation adjusted methods of providing depreciation has been examined. Simulation technique has been used to illustrate the problem and pertinent policy implications of the use of various depreciation methods have been highlighted.