It is popular misconception that the depreciation is a source of funds or working capital. This view is entirely indefensible because the funds are generated by the revenues from sales and other items of extraordinary income and not from depreciation. It is true that since the depreciation is a non- cash expense and unlike other operating expenses, does not require the use of funds or working capital but under no circumstances depreciation is a source of funds (working capital) or cash for that matter.

The misconception can be cleared with the help of the following journal entry that is usually passed for depreciation.

Depreciation Expense Account            Dr.
    To Accumulated Depreciation Account

The debit account is clearly an expense account and the credit account is contra fixed account. How can it be presumed from this journal entry that the depreciation is a source of funds or cash? When funds from operations are computed, the depreciation figure is added back. Such a procedure has led to a good deal of confusion because it is often concluded that depreciation is a source of funds.

Funds From Operation
    _______________________________Rs.
Net income as per Income Statement    50,000
Add: Non-cash expense: Depreciation     10,000
    60,000

Does it mean that out of total funds from operations (i.e., Rs.60,000), the contribution of depreciation is Rs. 10,000? The answer is flat ‘no’.

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