The accounting method that is used to allocate cost of tangible assets through its life span is called depreciation. Depreciation of long-term assets is done by firms for accounting and taxation requirements. Deduction of the cost of tangible assets purchased as business expense can help to save taxes.
However, all such depreciations should be carried out according to financial accounting rules. Knowledge of such rules can be obtained by searching for topics like depreciation homework answers online.
Depreciation does not involve actual flow of cash, so it becomes difficult for students to get clarity on the topic. It is an accounting procedure that permits a firm to write off the worth of an asset over its lifetime. Depreciation is a non-cash transaction; it determines the amount of the fixed assets value that has been utilized over its lifetime.
For example, when a firm purchases furniture for ease in operations at $25,000, while writing, the firm can either write the entire cost off in one year or the value can be divided throughout its lifetime that could be ten years. In addition to this, the furniture can be scrapped for &5,000, thus its salvage value becomes $5,000.
Using this data, analysts can calculate the expense of depreciation by subtracting the residual value from the price of the furniture and then dividing the value by the productâ€™s estimated productive life. Thus the calculation would be â€“
($25,000 – $5,000) / 10 = $2,000
Thus the firmâ€™s accountant will not have to write off the full amount of $25,000, though the amount has been paid. Instead, an expense of $2,000 can be written off every year till ten years. Students can practice more such examples to get clarity by searching online links like depreciation homework answers.
Values required for calculating depreciation
There are three main values that are required for the calculation of depreciation â€“
The time span within which a firm considers that the particular fixed asset will be productive is called the productive life of that asset. After this period use of that asset for productive operation does not prove to be fruitful.
After the productive life period of the fixed asset is over, the firm might consider selling the asset at a relatively lower rate. This rate is the salvage worth of that product.
This is the actual price of the fixed asset including the shipping charges, taxes, and manufacture/setting up costs for the product. Students can clarify their knowledge on these values by practicing few examples by searching topics like depreciation homework answers online.
Depreciation can be calculated by three different procedures â€“
Straight line process of finding depreciation expense
This is the easiest process involving allocation of equal amount of depreciation year after year through the period of the productive life of the fixed asset. The formula is â€“
EXPENSE OF ANNUAL DEPRECIATION = (COST OF ASSET â€“ SAVAGE VALUE) / PRODUCTIVE LIFE OF ASSET
For example, when a firm purchases equipment for production at $100,000, its productive life being 10 years, the residual value being $30,000, the expense of depreciation will be,
Expense of annual depreciation = ($100,000 â€“ $30,000) / 10 = $7,000
So, the firm can write off $7,000 as the expense of depreciation every year for the coming ten years.
Process using productivity
This process is different from the straight line process. This has two steps,and equal cost rates are provided to each produced unit. This is a very beneficial method for accounting production. The depreciation in this method is calculated by recording the production ability of a fixed asset instead of its productive life. The two steps involved in the calculation are â€“
Calculation of depreciation per unit, the formula is â€“
DEPRECIATION PER UNIT = (COST OF ASSET â€“ SALVAGE VALUE) / PRODUCTIVE LIFE IN TERMS OF PRODUCTION OF UNITS
Calculation of the depreciation of total units produced actually, the formula is â€“
DEPRECIATION EXPENSE IN TOTAL = DEPRECIATION PER UNIT * PRODUCED UNITS
For example, when a company buys a sewing machine worth $50,000 having productive life of 180,000 units with salvage value of $5,000, producing 5,000 jackets, then,
Depreciation per unit = ($50,000 – $5,000) / 180,000 = $0.25
Expense of total depreciation = $0.25 * 5,000 = $1250
So, here the full depreciation cost per unit is $1250. This can be utilized for output runs in future.
This is a method that uses accelerated depreciation process. It tracks twice the expense as the net asset value of an asset each year. The required formula is â€“
DEPRECIATION = 2 * DEPRECIATION PERCENT IN STRAIGHT LINE * INITIAL NET ASSET VALUE
NET ASSET VALUE = ASSET COST â€“ CUMULATIVE DEPRECIATION
Proper knowledge of all these types of depreciation calculation is necessary. For more clarity students can look for links to depreciation homework answers online and practice several real life examples.
Advantages of calculating depreciation expense
When an asset is put to use for different operations of business, its efficiency can be calculated over the years. Having an idea about depreciation expense of the fixed asset can help the firm to generate optimum use of asset. There are several advantages that a company can derive from calculation of depreciation expense â€“
Knowledge of depreciation expense helps a firm to report about an asset in terms of its net value. Initially, the fixed asset is recorded at its actual purchase cost. But the value of the fixed asset decreases with time owing to its usage that causes decrease in its efficiency. So, the value of the fixed asset should be determined according to its remaining net value. The net book value of the fixed asset is obtained by subtracting the accumulated depreciation from the purchase price of the fixed asset.
Calculation of the depreciation cost helps in showing a way to recover the price of the fixed asset. It is different from asset expensing where the cost is recovered immediately. Asset depreciation, on the contrary, helps in recovering the purchase price of the fixed asset throughout the period of its productive life. Online search on links like depreciation homework answers can give more idea on how calculation of depreciation expense can help in cost recovery of the fixed asset.
Knowledge of depreciation expense helps the firm to know the amount required to use the asset for several operations for the business during its operational cycle. This can be compared with the revenue that the asset generates when being used through that same period. This data can be help to use the asset optimally to generate the most amount of profit. Without proper knowledge of the expense of depreciation, the efficiency of the fixed asset cannot be adjusted according to requirement.
Depreciation expense calculation can help a company to get savings from tax. According to taxation rules, depreciation expense allows deduction of tax against revenue. Depreciation expense is inversely proportional to the taxable income, higher the depreciation cost, lower will be taxable income.
There are times when firms use accelerated depreciation values so that they can charge higher depreciation cost during periods when they might have higher revenue in order to lower the taxable income which results in achieving tax savings.
Knowledge of depreciation expense is very important in financial accounting, so, students can practice more real life examples by searching for topics like depreciation homework answers online.