Depreciation of Accounting

What Is Depreciation

The accounting concept is applicable in any industry. Depreciation is usually defined as the valuation of an asset, which requires a number of assumptions about a product's usage, maintenance, and expected future value to be determined at the start of the accounting period. Understanding the Key Concepts of Depreciation The true cost of an asset is then deducted from the asset's value, which is called the deferred asset cost. By assessing the depreciable life and the book value of the asset, the difference between the value of the asset at the beginning of the accounting period and the true cost of the asset is then recognized as a difference in gain or loss.

Accounting for Depreciation

Depreciation for a physical asset is calculated by dividing the cost of the asset by the assets' replacement cost, which is generally a one-time cost. The useful life of a physical asset is the average time an asset is in use. For example, an annual depreciation expense represents how much you have depreciated over the first 12 months of ownership. Calculating Depreciation for a Business Establish an accurate depreciation schedule by estimating the cost of the business and the cost of replacing that part of the business. Take the time to plan for any potential cost increases that will come with business growth. Depreciation works best when tracked for a reasonable time period.

Future Value

Future value represents the use of a tangible or intangible asset in the future. In the context of business, this refers to the value of a tangible or intangible asset based on the use that a future owner or user will make of the asset, whether it is in the form of an investment, a purchase or other activity. The value of a physical asset depreciated over a period of time represents the present value of the cost to the buyer of the asset at its purchase date. Examples Riding lawn mowers. Microfilm. Fork lift truck. These examples are illustrative and simplified in order to make depreciation an easy concept to understand. For more in-depth discussion about depreciation, refer to this great overview on Value, Use and Depreciation.

Tax Implications

When a business decides to purchase an asset, there are a number of decisions to be made. When a business purchases the asset, the initial cost of the asset is capitalized, which represents the accumulated value the asset holds at the time of acquisition. This is referred to as the cost basis. Any cost or depreciation incurred at that time is calculated as an expense against the asset's cost basis. The first tax advantage of depreciation is that depreciation can be carried over from year to year. Once this is done, the taxpayer can deduct the cost of the asset from their income and pay no tax on that charge. Income taxes on the amount of deductions received is to be determined based on the asset's fair market value at the end of the year.

Conclusion

Understanding depreciation will help you avoid giving false information to clients, better estimate costs, and better allocate your budget. If you do get a shock, don't despair. Adjust your estimate to the true value of the asset in the eyes of the business owner.