DEPRECIATION: 6 THINGS YOU SHOULD KNOW

Depreciation can be defined as the systematic allocation of the cost of an asset t throughout its useful life

We will look at six things you should know about depreciation in this post.

Forthwith, let's get started.

Statement #1: Depreciation allocates assets' cost

Depreciation can be defined as the decrease in the value of an asset over some time.

It is the systematic diminution in the value of a company's asset caused by a physical tear and wears.

Depreciation is just the matching concepts in action. Recall that the matching concept of accounting states that the revenue of a company should be matched with the expenses incurred in generating the revenue in the period they occur.

Assets must be depreciated to allocate the asset cost to the time they are utilized because they can generate income and are often used for a longer period.

Statement #2: Depreciation is caused by wear and tear, and other related factors.

Depreciation arises as a result of various factors including tear and wear, rust, decays, obsolescence, effluxion of time

Long-term use of equipment eventually results in wear and tear.

Similarly, Equipment made of metal will ultimately rust, especially if they are constantly exposed to rainfall.

Furthermore, an asset may become useless due to an organization's growth and expansion, which makes it no longer effective for large-scale production

Lastly, some assets such as lease equipment have a fixed period. For example, if an asset  is leased to a company for 5 years, it means that the company would allocate the cost of the assets to each period in the five years

Statement #3: Depreciation is a non-cash expense 

Unlike a typical expense in which a company have to make a cash payment, depreciation is a non-cash expense because it is the only used to offset the loss in the value of a business asset.

The cost of an asset is usually paid upfront but the cost of the asset will be depreciated over each period of its use.

Statement #4: Depreciation affects the amount of tax a company pay.

The taxes a company pay is directly proportional to its taxable income.

Taxable income, on the other hand, is the net profit, which is the difference between revenue and cost.

Depreciation is the systematic allocation of the cost of an asset. This means that depreciation adds to tax and, therefore, reduces taxable income.

This means more depreciation, fewer taxes; less depreciation, and more taxes.

Statement #5: Four things affect how depreciation is calculated.

The calculation of depreciation depends on four factors namely; the asset's cost, its estimated useful life, its residual value, and more importantly, the method of depreciation 

The asset cost is just the asset's purchase price plus any additional expenses incurred during the asset's acquisition

The estimated life of an asset refers to the number of years that a company expect to use an asset.

The residual value of an asset is simply the amount that a company expects to dispose of an asset at the end of its useful life. 

The method of depreciation is how a company depreciates its asset.

Statement #6: At least five methods exist to calculate depreciation.

There are at least five methods of depreciation, namely: straight line, reducing balance, sum-of-the-years digits, double declining and sinking fund method.

Straight line depreciation is a method of depreciation where a fixed percentage of an asset cost is allocated to each period an asset is used.

It is a depreciation method where an asset is depreciated by the same amount throughout its useful life.

Reducing balance depreciation is a method of deprecation where a fixed percentage of an asset's net book value is allocated to each period an asset is used.

The sum-of-the-years' digit depreciation is a depreciation method where a variable percentage of an asset's net book value is allocated to each period an asset is used.

Sum-of-the-years digit depreciation uses a variable percentage that depends on the asset's remaining useful years as well as the sum of the year's digits 

The double declining balance depreciation method, just as its name seems to suggest, involves decreasing the value of an asset at a pace that is twice that of a straight line depreciation,

The sinking fund method of depreciation is a depreciation method in which an asset is a depreciation in a way that funds are created for its replacement at the end of its useful life.

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