Why might a company establish an allowance for depreciation?

Establishing an allowance for depreciation is crucial for accurately reflecting the reduction of asset values over time. As physical assets, such as machinery, vehicles, and buildings, are used in operations, they naturally experience wear and tear, which decreases their value. This reduction is recognized through depreciation, allowing a company to allocate the cost of an asset over its useful life.

By doing so, the financial statements present a more realistic picture of the company's asset base and overall financial health. It also ensures that the expenses associated with these assets are matched with the revenues they generate during the accounting periods, adhering to the matching principle in accounting. This practice is essential for stakeholders, including investors and creditors, to assess the viability and operational efficiency of the business.