Depreciation, Cost Of Capital Assets Over Time......

Depreciation, In Accounting,
process of allocating in a systematic and rational manner the cost of a capital asset over the period of its useful life. Depreciation takes into account the decrease in the service potential of capital assets invested in a business venture, resulting from such causes as physical wear and tear in ordinary use, as in the case of machinery; deterioration primarily by action of the elements, as in the case of an aging building or the erosion of farmlands; or obsolescence that is caused by technological changes and the introduction of new and better machinery and methods of production. It is not, however, a process of recognizing changes in the fair market value of capital assets.

The cumulative depreciation since acquisition is reported on the balance sheet as a deduction from the cost of the related asset. The difference is referred to as the asset's “carrying amount” or “book value.” The periodic depreciation charge enters into the computation of net income.

Several methods are used by accountants in calculating periodic depreciation. The most widely used is the so-called straight-line method, in which the rate of depreciation is constant for the entire working life of the capital assets. Thus, if a machine cost $1100 and is assumed to have a 10-year useful life and a scrap value of $100 at the end of 10 years, the amount of annual depreciation would be $100 and the annual depreciation rate 10 percent (annual depreciation divided by cost minus scrap value). When the use of a capital asset is not constant over a period of time, a second method called the service-unit method or unit of production method is utilized. Here the scrap value is deducted from the cost of the asset and the remainder divided by the number of units (for example, miles or loads in the case of a truck, or number of units of output in the case of a machine) the asset is expected to yield. The result is depreciation expressed in units produced or units of service performed. Accelerated depreciation methods for example, applying a multiple of the straight-line depreciation rate to an asset's book value recognize the substantial consumption of some assets' service potential in early years. Depreciation methods allowable for purposes of computing taxable income are specified by statute and Internal Revenue Service regulations.

For depreciation, in the sense of a depreciated currency, that is, a currency that has declined in value, see Devaluation; Inflation and Deflation; Money.