Meaning of Depreciation

Depreciation

It is a reduction in the value of an asset over time, due in particular to wear and tear

Provision should be made for depreciation of a fixed asset

Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life

Depreciation allows a business to write off the loss or experiences through the wearing of assets

The basic general entry for depreciation is to debit the depreciation expense account (which appears in the income statement) and credit the accumulated depreciation amount

The accumulated depreciation account is an asset account with a credit balance

Depreciated cost is the remaining cost of an asset after the amount of accumulated depreciation has been deducted from it

Depreciation methods

1) straight-line method

It is a very common and simple method of calculating expense amount which is the same for every year over the useful asset life

Depreciation = (age of asset/life of asset) X Replacement value X (100 – salvage percentage)

2) double declining balance depreciation method

If results in larger expense in the earlier years as opposed to the later years of assets useful life

Depreciation = beginning book value X rate of depreciation

The beginning book value of an asset is filed at the beginning of year 1 and the salvage value is filled in the end of useful life

Rate of depreciation = (100% – useful asset life) X 2

3) units of production depreciation method

It depreciates assets based on the total number of hours used or the total number of units to be produced over its useful life

Depreciation = (number of units produced/life in number of Units) X (cost – salvage value)

4) Sum of the years digits depreciation method

The remaining life of an asset is divided by the sum of the years and then multiplied by the depreciating base to determine the expense

Depreciation = (remaining life / sum of years digit) X (cost – salvage value)

5) constant percentage method of depreciation

First, divide 100% by the number of years in the assets useful life

This, is, depreciation factor r which is constant for every year

Depreciation can not be deferred, often times the business loss that can result from the depreciation expense can be carried back or forward on your taxes

Deferred depreciation is the difference in depreciation expense taken for an asset between a tax book and it’s, associated corporate book. You can also project depreciation expense and use those values to determine future income tax liability

Whatever you claim depreciation, if reduces the tax basis of the asset in question

Depreciation allows the asset owner to divide asset cost over a number of years

Depreciation lowers the taxes

If the depreciated property is received as a gift, the assets basis is its fair market value whenever depreciation begins

Depreciation does not offset the gain if can actually increase the number of capital gains realized on the sale of property

Depreciation continues until the asset value declines to its salvage value

Depreciation allows you to deduct the inherited property value limited to structures, so you cannot deduct land value when depreciating the property

Compiled by

Avinash Kulkarni