Presentation on theme: "Accounting for Depreciation. Depreciation is the loss of value of fixed assets over time. Depreciation accounting is to account for the cost of fixed."— Presentation transcript:
Accounting for Depreciation
Depreciation is the loss of value of fixed assets over time. Depreciation accounting is to account for the cost of fixed assets in a pattern that matches their decline in value over time. The process of depreciating an asset requires that we know some things: What is the cost of the asset? What is the depreciable life of the asset? What is the asset’s value at the end of its useful life? What method of depreciation do we choose?
A depreciable asset is property for which a firm may take depreciation deductions against income. U.S tax law requires the depreciable property must: Be used in business or held for the production of income Have a definite service life, which must be longer than 1 year Be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes
Depreciable property includes buildings, machinery, equipment, vehicles, and some intangible properties Inventories are not depreciable property because they are held primarily for sale to customers in ordinary course of business. If an asset has no definite service life, it cannot be depreciated. Land can never be depreciated, but any land improvements have a limited useful life, so they are subject to depreciation
The cost basis represents the total cost that is claimed as an expense over the asset’s life Total cost, rather than the cost of the asset only, must be the basis for depreciation charged as an expense over an asset’s life.
Asset depreciation ranges (ADRs) are guidelines that specify a range of lives for classes of assets, based on historical data, allowing taxpayers to choose a depreciable life of a given asset. Salvage value is the estimated value of an asset at the end of its useful life; the amount eventually recovered through sale, trade-in, or salvage.
Book depreciation is depreciation calculated for financial reports, such as a balance sheets or income statements. It enables firms to report depreciation to stockholders, where actual loss in the value of the asset is reflected.
Three different methods can be used to calculate the periodic depreciation allowances for financial reporting: Straight-line (SL) method Declining-balance (DB) method Unit-of-production method
The straight-line method of depreciation interprets a fixed asset as an asset that provides its service in a uniform fashion. Depreciation rate is 1/N, where N is the depreciable life. Dn = (1/N) * (I – S) Excel: =SLN(cost, salvage, life)
The declining-balance method recognizes that the stream of services provided by a fixed asset may decrease over the asset’s service life α = (1/N) (multiplier) Dn = α * (Bn of previous year) Most common multipliers used in the U.S. are 1.5 (called 150% DB) and 2.0 (called 200% DDB, or double-declining-balance)