Equipment depreciation is the loss of value of equipment used for business purposes each year, which can be written off for tax purposes. The amount of depreciation depends on the equipment’s useful life and depreciation method, such as straight-line or declining balance.
Equipment depreciation refers to the process by which equipment used for business purposes loses value during each year of its useful life. This is an important concept for business owners to understand as they are allowed to write off this loss in value each year for tax purposes. The amount of equipment depreciation each year depends on how many years the equipment is scheduled to be used and the depreciation method used. Most often, depreciation is calculated using the straight-line method or the declining balance method.
Many businesses rely on various equipment to operate on a daily basis, such as the machinery used in factories or the various tools used in construction. Every year that this equipment is in use, it loses a little bit of value, until eventually it reaches a point where it has little or no value to the company due to the wear and tear it has endured. The lost value is known as equipment depreciation, a concept by which companies can offset that lost value in tax write-offs.
Any equipment used for business purposes for a period greater than one year is subject to equipment depreciation. This lost annual amount is reported on tax returns as depreciation expense and differs from accumulated depreciation, which is recognized on the balance sheet as a current amount. For example, a piece of equipment that depreciates by $200 each year will have a depreciation expense of that amount each year, but accumulated depreciation will be $200 the first year, $400 the next. year, and so on.
The amount of equipment depreciation realized each year depends on the depreciation method used. In the straight-line method, equipment depreciates the same amount each year, an amount reached by dividing the cost of the equipment by its useful life. For example, if a piece of equipment is worth $500 to purchase and has a useful life of five years, you would have a depreciation expense of $100, or $500 divided by five.
Some companies prefer to spend more on equipment in the year it is purchased, and the declining balance method of equipment depreciation allows for this. In this method, a depreciation percentage rate is applied to the original cost balance. Using the example above, if the depreciation rate is 50 percent, the first year’s depreciation expense will be $500 multiplied by 0.5, which equals $250. Next year, the cost balance would drop to $250, or $500 minus $250, and the 50 percent rate would be applied to that amount to calculate depreciation expense for the second year.
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