From Wikicpa

Declining-balance depreciation of a $50,000 asset with $6,500 salvage value over 20 years.

Depreciation is an accounting and finance term for the method of attributing the cost of an asset across the useful life of the asset. Depreciation is an example of applying the matching principle as per generally accepted accounting principles.

Depreciation is a reduction in the value of a currency in floating exchange rate.

Depreciation is often mistakenly seen as a basis for recognizing "wear and tear", obsolescence, or impairment on an asset, but these issues, where seen as significant enough to account for, are handled through an asset revaluation reserve.

The use of depreciation affects the financial statements and in some countries the taxes of companies and individuals.

In economics depreciation is the decrease in value of the capital stock, physical depreciation. If capital stock is C₀ at the beginning of a period, investment is I and depreciation D, the capital stock at the end of the period, C₁, is C₀ + I − D.

Accounting

A company needs to report depreciation accurately in its financial statements in order to achieve two main objectives. First, to match its expenses with the income generated by means of those expenses. Second, to ensure that the asset values in the balance sheet are not overstated. An asset acquired in Year 1 is unlikely to be worth the same amount in Year 5.

Depreciation is an average or expected view of the decline in value of an asset. For example, an entity may depreciate its equipment by 15% per year. This rate should be reasonable in aggregate (such as when a manufacturing company is looking at all of its machinery), but there is no expectation that each individual item declines in value by the same amount.

Accounting standards bodies have detailed rules on which methods of depreciation are acceptable, and auditors will express a view if they believe the assumptions underlying the estimates do not give a true and fair view.

Recording depreciation

For historical cost purposes, assets are recorded on the balance sheet at their original cost this is called the book value. Depreciation is not taken out of these assets directly. It is instead recorded in a contra asset account: an asset account with a normal credit balance, typically called "accumulated depreciation". Balancing an asset account with its corresponding accumulated depreciation account will result in the net book value. The net book value will never fall below the salvage value, meaning that once an asset is fully depreciated, no further expenses will be taken during its life. Companies have no obligation to dispose of depreciated assets, of course, and many depreciated assets continue to generate income.

Recording a depreciation expense will involve a credit to an accumulated depreciation account. The corresponding debit will involve either an expense account or an asset account which represents a future expense, such as work in process. Depreciation is recorded as an adjusting journal entry.

A write-down is a form of depreciation that involves a partial write off. Part of the value of the asset is removed from the balance sheet. The reason may be that the book value (accounted value) of the fixed asset has diverged from the market value.

Methods of depreciation

There are several methods for calculating depreciation, generally based on either the passage of time or the level of activity (or use) of the asset.

Straight-line depreciation

Straight-line depreciation is the simplest and most often used technique, in which the company estimates the "salvage value" of the asset after the length of time over which it is depreciated, and assumes the drop in the asset's value is in equal, constant yearly increments over that amount of time. The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero. For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a "salvage value" of US$2000 will depreciate at US$3,000 per year. ($17,000 − (5 x $3000)) = $2000

If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess depreciation would be considered as income by the tax office (capital gains). If the sales price is less than the book value, the resulting capital loss is tax deductible.

If a company chooses to depreciate an asset at a different rate from that used by the tax office then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit.

Declining-balance depreciation

The declining-balance method is a type of accelerated depreciation, because it recognizes a higher depreciation cost earlier in an asset's lifetime. This may be a more realistic reflection of an asset's actual resale value, as well as the expected benefit from the use of the asset: many assets are most useful when they are new. In the U.S., a form of double declining-balance depreciation, MACRS, is used for tax purposes and is based on time.

In declining-balance depreciation, each period's depreciation is based on the previous year's net book value, the estimated useful life, and a factor. The factor is commonly two; this is known as double declining-balance. Each period we calculate depreciation:

For the double-declining balance method, using the vehicle example from above, we compute the depreciation after the first year:

We subtract $6800 from our previous year's net book value to obtain our new net book value: . For the second year, we use this new value to calculate depreciation. Notice that it is significantly lower than the first year:

This process continues until we reach the salvage value or the end of the asset's useful life. Since declining-balance depreciation doesn't always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life.

Sum of years digits depreciation

Sum of Years Digits is a historical depreciation method that results in a more accelerated write off than straight line, but less than declining balance or later methods. Salvage value is counted in the method. There are no property classes of later methods.

• Given;
  • N = Depreciable life of asset
  • B = Cost basis
  • S = Salvage value
  • D(t) = Depreciation charge for year t
  • 
  • 

Example: If an asset costs $1000, has a depreciable life of 5 years and a salvage value of $90, compute its depreciation schedule.

Year	D(t)	Sum of D(t)	Remaining Book Value
1	$303	$303	$697
2	$242	$546	$454
3	$182	$728	$272
4	$121	$849	$151
5	$61	$910	$90

The equation for year 1 would look like this:

Note: Most depreciation schedules round to the nearest dollar.

See also

• Amortization
• Expense