What is the purpose of an allowance for depreciation?

The purpose of an allowance for depreciation is fundamentally tied to the accounting treatment of fixed assets. It serves to accumulate the decreases in value of fixed assets over time due to wear and tear, obsolescence, or other factors affecting their useful life. This accounting practice ensures that the expense related to the usage of an asset is appropriately matched with the revenue it helps generate, adhering to the matching principle in accounting.

By establishing an allowance for depreciation, businesses can provide a more accurate representation of their financial position, as it reflects not only the original cost of their assets but also their current value after accounting for depreciation. This allows stakeholders, such as investors and management, to understand the true financial health and asset valuation of the business.

Other options refer to different accounting concepts that do not relate directly to the purpose of depreciation. Tracking cash flow, recording accounts receivable, or calculating total liabilities are distinct financial activities that serve different purposes in financial reporting and management.