Depreciation

Definition§

Depreciation is an accounting method that allocates the cost of a tangible asset over its useful life. It represents how much of an asset’s value has been used up over a period. Companies use depreciation to allocate the cost of an asset systematically over its useful life, rather than expensing it all at once. This practice adheres to the matching principle of accounting, which aims to match expenses with generated revenues.

Examples§

1. Straight-Line Depreciation: A company purchases machinery worth $100,000 with an expected useful life of 10 years and a salvage value of $10,000. The annual depreciation expense would be calculated as ($100,000 - $10,000) / 10 = $9,000 each year.

2. Declining Balance Depreciation: For the same machinery worth $100,000 with a 10-year useful life, if the company chooses a double declining balance method, the first year’s depreciation would be 2 * (1/10) * $100,000 = $20,000. In subsequent years, the depreciation amount would decrease as it applies to the asset’s book value at the start of the period.

Frequently Asked Questions (FAQs)§

Q1: Can land be depreciated?

• Answer: No, land cannot be depreciated because it does not wear out, become obsolete, or get used up.

Q2: What is the purpose of depreciation?

• Answer: Depreciation aims to allocate the cost of a tangible asset over its useful life and match it with the revenue generated by the asset, following the matching principle of accounting.

Q3: How does depreciation affect financial statements?

• Answer: Depreciation reduces an asset’s book value on the balance sheet and reduces net income on the income statement by the depreciation expense.

Q4: Can depreciation be used for tax purposes?

• Answer: Yes, the IRS allows businesses to deduct depreciation expenses from their taxable income, reducing the tax liability.

Related Terms§

• Amortization: The process of gradually writing off the initial cost of an intangible asset over its useful life.

• Accumulated Depreciation: The total amount of depreciation expense that has been recorded against a particular asset since it was put into use.

• Salvage Value: The estimated residual value of an asset at the end of its useful life.

• Useful Life: The estimated duration over which a fixed asset is expected to be used for its intended purpose.

• Book Value: The value of an asset as it appears on the balance sheet, calculated as the cost of the asset minus accumulated depreciation.

Online References and Resources§

1. Investopedia on Depreciation
2. IRS Publication on How to Depreciate Property
3. Wikipedia: Depreciation
4. Accounting Coach: Depreciation

Suggested Books for Further Studies§

1. “Intermediate Accounting” by Donald E. Kieso, Jerry J. Weygandt, and Terry D. Warfield
   • An authoritative guide covering financial accounting concepts, including depreciation.
2. “Principles of Accounting” by Weygandt, Kimmel, and Kieso
   • A foundational textbook providing in-depth coverage of basic accounting practices, including asset depreciation.
3. “Financial Accounting” by Robert Libby, Patricia Libby, and Frank Hodge
   • A comprehensive overview of financial accounting that discusses depreciation of assets.

Fundamentals of Depreciation: Accounting Basics Quiz§

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