Depreciation
From Wikipedia, the free encyclopedia
Jump to navigation
Jump to search
Not to be confused with Deprecation.
This article is about the concept in accounting and finance involving fixed capital goods. For
economic depreciation, see Depreciation (economics) and Fixed capital § Economic
depreciation. For the decrease in value of a currency, see Currency depreciation.
An asset depreciation at 15% per year over 20 years
In accountancy, depreciation is a term that refers to two aspects of the same concept: first, the
actual decrease of fair value of an asset, such as the decrease in value of factory equipment
each year as it is used and wear, and second, the allocation in accounting statements of the
original cost of the assets to periods in which the assets are used (depreciation with the
matching principle).[1]
Depreciation is thus the decrease in the value of assets and the method used to reallocate, or
"write down" the cost of a tangible asset (such as equipment) over its useful life span.
Businesses depreciate long-term assets for both accounting and tax purposes. The decrease in
value of the asset affects the balance sheet of a business or entity, and the method of
depreciating the asset, accounting-wise, affects the net income, and thus the income statement
that they report. Generally, the cost is allocated as depreciation expense among the periods in
which the asset is expected to be used.
Methods of computing depreciation, and the periods over which assets are depreciated, may
vary between asset types within the same business and may vary for tax purposes. These may
be specified by law or accounting standards, which may vary by country. There are several
standard methods of computing depreciation expense, including fixed percentage, straight line,
and declining balance methods. Depreciation expense generally begins when the asset is
placed in service. For example, a depreciation expense of 100 per year for five years may be
recognized for an asset costing 500. Depreciation has been defined as the diminution in the
utility or value of an asset and is a non-cash expense. It does not result in any cash outflow; it
just means that the asset is not worth as much as it used to be. Causes of depreciation are
natural wear and tear[citation needed].
Contents
●
●
●
●
1
Accounting concept
○ 1.1
○ Depreciable basis
○
○ 1.2
○ Impairment
○
○ 1.3
○ Depletion and amortization
○
○ 1.4
○ Effect on cash
○
○ 1.5
○ Accumulated depreciation
○
2
Methods for depreciation
○ 2.1
○ Straight-line depreciation
○
○ 2.2
○ Diminishing balance method
○
○ 2.3
○ Annuity depreciation
○
○
○
○
○
○
○
○
○
○
○
○
○
●
●
●
●
●
●
●
●
●
●
●
●
●
●
2.4
Sum-of-years-digits method
2.5
Units-of-production depreciation method
2.6
Group depreciation method
2.7
Composite depreciation method
3
Tax Depreciation
○ 3.1
○ Capital allowances
○
○ 3.2
○ Tax lives and methods
○
○ 3.3
○ Additional depreciation
○
○ 3.4
○ Real property
○
○ 3.5
○ Averaging conventions
○
4
Economics
5
See also
6
References
7
Further reading
Accounting concept[edit]
In determining the net income (profits) from an activity, the receipts from the activity must be
reduced by appropriate costs. One such cost is the cost of assets used but not immediately
consumed in the activity.[2] Such cost allocated in a given period is equal to the reduction in the
value placed on the asset, which is initially equal to the amount paid for the asset and
subsequently may or may not be related to the amount expected to be received upon its
disposal. Depreciation is any method of allocating such net cost to those periods in which the
organization is expected to benefit from the use of the asset. Depreciation is a process of
deducting the cost of an asset over its useful life.[3] Assets are sorted into different classes and
each has its own useful life. The asset is referred to as a depreciable asset. Depreciation is
technically a method of allocation, not valuation,[4] even though it determines the value placed
on the asset in the balance sheet.
Any business or income-producing activity[5] using tangible assets may incur costs related to
those assets. If an asset is expected to produce a benefit in future periods, some of these costs
must be deferred rather than treated as a current expense. The business then records
depreciation expense in its financial reporting as the current period's allocation of such costs.
This is usually done in a rational and systematic manner. Generally, this involves four criteria:
●
●
●
Cost of the asset
Expected salvage value, also known as the residual value of the assets
Estimated useful life of the asset
●
A method of apportioning the cost over such life[6]
Depreciable basis[edit]
Cost generally is the amount paid for the asset, including all costs related to acquiring and
bringing the asset into use.[7] In some countries or for some purposes, salvage value may be
ignored. The rules of some countries specify lives and methods to be used for particular types of
assets. However, in most countries the life is based on business experience, and the method
may be chosen from one of several acceptable methods.
Impairment[edit]
Accounting rules also require that an impairment charge or expense be recognized if the value
of assets declines unexpectedly.[8] Such charges are usually nonrecurring, and may relate to
any type of asset. Many companies consider write-offs of some of their long-lived assets
because some property, plant, and equipment have suffered partial obsolescence. Accountants
reduce the asset's carrying amount by its fair value. For example, if a company continues to
incur losses because prices of a particular product or service are higher than the operating
costs, companies consider write-offs of the particular asset. These write-offs are referred to as
impairments. There are events and changes in circumstances might lead to impairment. Some
examples are:
●
●
●
●
Large amount of decrease in fair value of an asset
A change of manner in which the asset is used
Accumulation of costs that are not originally expected to acquire or construct an
asset
A projection of incurring losses associated with the particular asset
Events or changes in circumstances indicate that the company may not be able recover the
carrying amount of the asset. In which case, companies use the recoverability test to determine
whether impairment has occurred. The steps to determine are: 1. Estimate the future cash flow
of asset (from the use of the asset to disposition) 2. If the sum of the expected cash flow is less
than the carrying amount of the asset, the asset is considered impaired