Changes

'''Depreciation''', in general conversation, is the decline in value of an [[asset]] due to wear and tear, becoming outdated, or actual destruction.  Cars, homes, computers, factories, and all types of equipment undergo depreciation.

In [[accounting]], '''depreciation''' is a process whereby the value of an [[asset]] is allocated over a period of time.  The concept comes from the fact that, over time, all assets decline due to normal wear and tear, obsolescence, or actual destruction.  All assets of a business are depreciated, except for real estate (which appreciates over time in most cases) and some unusual items such as artwork or vintage automobiles.

In [[accounting]], depreciation is not an attempt to value an asset, but rather to allocate its cost over a period of time. The basic formula for depreciation is Cost minus salvage value, the result of which is divided by service life.  While there are many different ways to calculate depreciation, the easiest to understand is straight line.

In order to determine depreciation the company needs to determine four things about the asset:

*First, it needs to determine its [[historical cost]].  The cost is not just that of the asset, but may also include sales/use taxes, freight/shipping, and costs to install and test the asset for its intended use.

*Second, it needs to determine its useful life.  This can be in terms of years or some unit of use or production.

*Third, it needs to determine its '''residual value''' (also called '''salvage value''' or '''scrap value''', though it does not mean the asset is nothing but scrap or salvage at the end of its useful life).  Although there are cases where an asset may have a negative residual value at the end of its useful life, for accounting purposes a residual value below zero is not used.

*Finally, it needs to determine a method of depreciation.  Common methods of depreciation include '''straight-line''' (this is the most common and easiest to understand), '''units''', '''declining balance''', and '''sum-of-the-years-digits'''.

Suppose a company buys machinery for $50,000, expects it to last seven years and be sold for scrap for $1,000 at the end of seven years.  Under straight line depreciation methods, the machine would be depreciated at $7,000 per year.

It should be noted that once an asset is fully depreciated, the company is still allowed to use the asset for business purposes.  Also, a company will have a depreciation policy which states how various broad categories of assets will be depreciated, and may use different methods for different assets.

 

A company buys machinery for $50,000, expects it to last five years, and at that time have a residual value of $5,000.  Under straight line depreciation methods, the machine would be depreciated at $7,000 per year.

==U.S. Tax Code==

==U.S. Tax Code==