# Why Provide for Depreciation Before Declaring Dividend?
## 1. Source Principle
Dividend is an apportionment from revenue profits. It must never be paid out of capital, because doing so reduces the capital base that protects creditors.
## 2. Nature of Depreciation
Depreciation is a notional estimate of the reduction in the value of a fixed asset due to:
- Wear and tear during use,
- Efflux of time,
- Improvements in technology (obsolescence), etc.
It is a real economic cost even though no cash leaves the company.
## 3. Consequences If Depreciation Is NOT Provided
| Effect | What Happens |
|---|---|
| (a) | Balance Sheet shows asset at an overstated value |
| (b) | Profit & Loss A/c shows overstated profits |
| (c) | Dividend paid out of these inflated profits effectively becomes a dividend out of capital |
## 4. Legal Mandate
Section 123(1) read with Sec 123(2) mandates that depreciation must be provided as per Schedule II to the Companies Act, 2013 before any dividend is declared.
## Logic
If a machine bought for ₹100 lakh loses ₹10 lakh in value during the year, and depreciation is not charged, the company will report inflated profits. Distributing dividend out of those inflated profits means returning shareholders' own capital to them — a fraud on creditors and a hidden capital reduction.
## Key Takeaway
Depreciation per Schedule II = mandatory deduction before dividend. No exceptions. This preserves the integrity of the 'profits' from which dividend can lawfully flow.