Depreciation and Your Business

Depreciation is the systematic deduction of the worth of assets that are used in production. The assets are the capital investments a company makes to enable production of goods or services. They include equipments and machinery, vehicles, and buildings among others. They are not recorded as expenses. Because these are resources, they are assigned a useful life span. Based on an estimate of the life of an asset minus the salvage value, entities are allowed to distribute the worth of the asset over the period of use of the asset measured in years in most cases. What this means is that at the end of each year, the worth of the asset is deducted because it is no longer expected to as productive as it was at the beginning of the year. There are different methods of depreciation.

Straight-line Depreciation:
The straight-line depreciation method allows entities to calculate the worth of an asset and distribute an even deduction of the amount on a yearly basis over the life of the asset. In this case the cost of the asset minus the estimated salvage value divided by the estimated useful life of the asset. The salvage value is what the asset is expected to fetch when sold at the end of its useful life.

Straight-line depreciation can also be measured in units-of production. In this case, the cost of each unit is calculated and that cost is multiplied by the number of units produced in every given year and that amount is deducted as the depreciated value of the asset. In this case, the cost minus the estimated salvage value divided by the estimated total units to be made.

Accelerated Depreciation:
In the accelerated depreciation method the basic premise consists of depreciating a greater part of the value of the asset in the earlier life of the asset which would be reflected as a greater cost and less income in the financial statement. In this case, either the sum-of-the-years' digits or the double-declining method is used. In this method, the annual depreciation expense is the cost minus the estimated salvage value and that is multiplied by the remaining life in years divided by the sum-of-the-years' digits.

An alternative accelerated depreciation method the double-declining method. In this case the straight-line depreciation rate is doubled before being multiplied by the cost minus the salvage value.

Annual Depreciation expense is equal; double straight-line depreciation rate multiplied by the asset's net value.

The straight-line rate is calculated by one divided by the life in years multiplied by one hundred.

What is depreciation used for?
Depreciation has a tax value. It does not result in a tax return but companies deduct the depreciated value and taxes are based on post depreciated amounts. For this reason, the Internal Revenue Service came up with guidelines and publications on how to handle depreciation.

Modified Accelerated Cost Recovery System (MACRS).
MACRS is an Internal Revenue Service (IRS) standard by which companies depreciate assets. Under this act, assets were classified under specific categories with each category having specific depreciation methods including 150% declining balance method for machinery. Also, under this code the recovery method was lengthened. This ensures that though the double-declining method allows for earlier or quicker depreciation of an asset, depreciation will be more leveled out as apposed to a steep curve. One of the categories in MACRS remained specific to buildings which instead of depreciating generally appreciate in value or have a longer life span. MACRS maintained a straight-line method for buildings.

"Depreciation is not an attempt to recognize a loss in market value or any value between the original cost and replacement cost of an asset."

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