Depreciation cost is the loss of value in an item over time, with four approved methods for calculation. It should be shown separately in financial statements and adjusted for the amount that could be obtained if sold. Straight-line, declining balance, and percentage of use are common methods.
Depreciation cost is a term used to account for the loss of value in an item over time. There are four depreciation methods that are approved for use under generally accepted accounting principles, or GAAP. The most commonly used methods are straight-line depreciation, declining balance, and percentage of use.
The depreciation cost should be shown as a separate item in the company’s financial statements. The calculation method will be provided in the notes to the financial statements. If the method used is changed, this should be clearly noted in the notes, as it has a significant impact on the financial statements.
There are two costs for a fixed asset: the purchase price or book value and the adjusted or depreciated cost. The purchase price is the amount of the original equipment cost. This is used as the dollar value of the equipment. However, this value needs to be adjusted to indicate the amount that could actually be obtained if the equipment were sold. This is the amortized or adjusted value.
A common example of depreciation cost is the difference in value between a new car and a used car. The value of the new car is the purchase price. However, as soon as it is used, the value drops to a lower value, depending on the distance traveled or the use of the vehicle. The difference between these two values is the deprecation cost. In accounting, this difference must be calculated and applied equally to all assets.
Under straight-line depreciation, the annual value of depreciation is the total cost of the item divided by the estimated useful life. The same value is used each year. At the end of the unit’s useful life, the asset has a value of zero. The unit may continue to be used, but it is not shown as an asset in the financial statements.
Declining balance depreciation uses a higher depreciation rate in the first year. The calculation used is the depreciation rate multiplied by the purchase price or book value of the item at the beginning of the fiscal year. The depreciation rate used is based on the asset class and the generally accepted rate. A common source for this rate is the depreciation guidelines used for income tax purposes.
The percent-of-use method of calculating depreciation cost takes the purchase price of the asset and multiplies it by a percent-of-use factor. This value can be based on the number of units produced, the distance traveled, or the hours of operation. The value of the asset decreases as it is used, until the maximum use value is reached. At this point, the value of the asset is zero.
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