Depreciation Advantages And Disadvantages

Depreciation Depreciation is a method of allocating the cost of a tangible asset over its useful life. In accountancy, depreciation refers to two aspects which is the decrease in value of asset and allocation of the cost of assets to period in which the assets are used. During each accounting period, a portion of these costs is being used up. The portion being used up is considered as depreciate expenes and recorded on the financial statement. A business must record a depreciation based on consistency concept. It is due to the reason that a business enable to compare the financial statements of one year with another. Besides, it also can make comparisons with other similar business’s financial statemens.

Factors causes Depreciation

One major advantage of depreciation expenses is that depreciation expenses help companies state the amount of expenses incurred as a result of using an asset during an accounting period correctly match with the revenue that the asset use intends to generate in the same period. Companies may overstate or understate total expenditure without appropriately charging an asset purchase cost to depreciation expenses. Thus, companies may misstate revenue, reporting misleading financial information. Besides, using depreciation expenses can also helps companies or organization accurately report assets at their net book value. In the beginning, companies record fixed assets by using the original purchase cost. However, asset value decrease over time as the result of asset uses that likely cause an asset’s wear and tear. Hence, companies must adjust an asset value to it’s the net remaining value. An asset net book value is the original purchase cost decrease by the asset accumulated

Tax rules allow depreciation be use as the tax deduction against revenue in arriving at taxable income. The higher the depreciation expenses, the lower the taxable income. So, companies can get more tax savings if the depreciation of an asset is higher. When companies expect to have higher revenue, they will use accelerated depreciation to charge higher depreciation expenses in certain periods to purposely lower taxable income and achieve tax savings.

Methods of Depreciation In accounting, there are several methods to calculate depreciation. Straight line method and reducing balance method are common methods that companies apply to calculate depreciation.

Straight Line Method Straight line method is a method of calculating depreciation by taking an equal amount of the asset’s cost as expenditure for each year of the asset’s useful life. Residual value which also known as scrap value, is the estimated proceeds expected from the disposal of an asset at the end of its useful life. Besides, useful life is the estimated time period that the asset is expected to be used starting from the date for use up to the date of its disposal or terminate of use. The formula of straight line method to calculate depreciation is shown in below. Depreciation Expenses = ( Cost of Fixed Asset-Residual value)/(Useful life of