1. Accounting for Depreciation

2.  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?

3.  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

4.  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

5.  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.

6.  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.

7.  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.

8.  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

9.  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)

10.  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)