When a company acquires an asset that is expected to be used for more than one year, the cost of the asset cannot be expensed in the year it is acquired but must be capitalized and allocated over the asset's useful life. This process is called depreciation and allows the company to recover the cost of the asset over time rather than all at once.

1. What is Depreciation?

Depreciation is the systematic allocation of the cost of a tangible asset over the period of its useful life. It is an accounting method that reduces the value of an asset gradually, over time. The purpose of depreciation is to reflect the asset's decline in value due to wear and tear, age, or obsolescence. Depreciation is recorded as an expense on the income statement and is accumulated in a contra-asset account called accumulated depreciation.

2. Where is Depreciation Recorded?

Depreciation is recorded on the balance sheet as a reduction in the value of the asset and on the income statement as an expense. The accumulated depreciation is recorded as a contra asset account, meaning it is deducted from the asset's cost to arrive at the asset's net book value. The net book value is the asset's cost minus the accumulated depreciation.

3. How is Depreciation Calculated?

There are several methods for calculating depreciation, including:

• Straight-line depreciation: This method allocates the cost of the asset evenly over its useful life.
• Declining balance depreciation: This method allocates a larger portion of the asset's cost to the early years of its life.
• Sum-of-the-years' digits depreciation: This method allocates a decreasing portion of the asset's cost to each year of its life.

4. What Assets are Depreciable?

Depreciable assets are tangible assets that have a useful life of more than one year. Examples of depreciable assets include:

• Buildings
• Equipment
• Machinery
• Vehicles
• Furniture

5. Why is Depreciation Important?

Depreciation is important for several reasons, including:

• It matches expenses to revenues: Depreciation expense is recorded over the asset's useful life, which matches the period in which the asset is used to generate revenue.
• It allocates the asset's cost over its useful life: Depreciation expense is allocated over the asset's useful life, which ensures that the asset's cost is recovered over the period in which it is used.
• It provides a tax deduction: Depreciation expense is a tax-deductible expense, which can reduce a company's taxable income.

Conclusion

Depreciation is an accounting method that allocates the cost of a tangible asset over its useful life. Depreciation expense is recorded on the income statement and accumulated depreciation is recorded as a contra-asset account on the balance sheet. Depreciation is important because it matches expenses to revenues, allocates the asset's cost over its useful life, and provides a tax deduction.

Frequently Asked Questions

1. What is the difference between depreciation and amortization?

Depreciation is the systematic allocation of the cost of a tangible asset over its useful life, while amortization is the systematic allocation of the cost of an intangible asset over its useful life.

2. What are the different methods for calculating depreciation?

The three most common methods for calculating depreciation are straight-line depreciation, declining balance depreciation, and sum-of-the-years' digits depreciation.

3. What assets are depreciable?

Depreciable assets are tangible assets that have a useful life of more than one year. Examples of depreciable assets include buildings, equipment, machinery, vehicles, and furniture.

4. How does depreciation affect a company's financial statements?

Depreciation expense is recorded on the income statement and accumulated depreciation is recorded as a contra-asset account on the balance sheet. Depreciation expense reduces a company's taxable income, which can save the company money on taxes.

5. Why is depreciation important?

Depreciation is important because it matches expenses to revenues, allocates the asset's cost over its useful life, and provides a tax deduction.