Meaning of Depreciation

Depreciation is the process of subtracting the total cost that has been used of an eligible Asset purchased for the business for a particular period. However, instead of expending the entire cost in one year, you deduct portions of it over time. When you depreciate assets, you may decide how much money is written off each year, providing you with greater financial control.

The useful life of a product determines the number of years it gets depreciated over (e.g., a laptop is useful for about five years). Different assets are classified under different rates of depreciation for tax purposes.

If your company utilises a different method of depreciation for its financial statements, you may determine the useful life of an asset depending on how long you plan to use it in your firm.

For example, the Income Tax Act may mandate that computer equipment be depreciated for five years, but if you know it will be obsolete in three years, you can depreciate it over a shorter period of time.

What exactly is depreciation?

Depreciation is defined in accounting as the systematic expensing of the reported cost of a fixed asset until the asset’s value is zero or inconsequential.

A few examples of fixed assets are buildings, office equipment, furniture, machinery, and more. The land is the lone exception that cannot be depreciated since its value increases with time.

What Causes Asset Depreciation over Time?

New assets are usually worth more than older ones. Depreciation is a measure of how much an asset loses in value over time, either directly through continued usage via wear and tear or indirectly from the introduction of new product models and variables such as inflation.

For Tax Purposes, How Are Assets Depreciated?

When individuals talk about accounting depreciation, they frequently refer to depreciation. This is the process of distributing an asset’s cost across its useful life in order to match costs with income creation.

Accounting depreciation schedules are also created with tax advantages in mind because depreciation on assets is deductible as a company cost under Income Tax Act. Depreciation schedules might be basic straight-line, accelerated, or per-unit.

Understanding Depreciation in Accounting and Business

Depreciation is a cost, which means it appears on your income statement as a line item and affects net income. Many small-business owners are perplexed by depreciation since the depreciation expenditure on the income statement does not correspond to cash flow.

Depreciation is not a monetary cost. In other words, a company does not write a check to “depreciation.” Instead, the cost of the asset is recorded or recognised on the income statement over time. As a result, depreciation frequently does not correspond with when the firm purchases the asset, even if the purchase is paid in instalments over time.

Depreciation is a notion that links spending to a certain time period, although it is not strictly an accrual-basis idea. This computation will show on both cash and accrual financial statements.

Types of Depreciation Methods 

Written down value 

In the WDV method, the amount of depreciation keeps decreasing with time as it is considered that an asset gives more value to a business in the initial years than the later years, therefore, this method is considered as the most logical method of depreciation and this method is also called as reducing balance method

Units of production

The units of production approach is based on the utilisation, activity, or units of products produced of an item. As a result, depreciation would be larger during high utilisation times and reduced during low usage periods. This approach can be used to depreciate assets where usage variance is significant, such as vehicles based on kilometres travelled or photocopiers based on copies created.

Straight Line Method

The straight-line depreciation technique reduces the value of an asset consistently over time until it reaches its salvage value. Straight-line depreciation is the most popular and easiest way of distributing the cost of a capital asset. It is computed by dividing the cost of an item, minus its salvage value, by the asset’s usable life.

Conclusion 

Depreciation is the process of subtracting the total cost of an expensive thing purchased for your firm. The useful life of a product determines the number of years it gets depreciated over. If your company utilises a different method of depreciation for its financial statements, you may determine the useful life of an asset depending on how long you plan to use it in your firm. Depreciation is defined in accounting as the systematic lowering of the reported cost of a fixed asset until the asset’s value is zero or inconsequential. Depreciation is a measure of how much an asset loses in value over time, either directly through continued usage via wear and tear or indirectly from the introduction of new product models and variables such as inflation.