Depreciation is a non-cash expense in accounting, which represents the cost of using the asset over the course of its useful life. Although depreciation doesn't represent an actual cash outflow, it is still an expense and a major component in determining net income. There are various methods for calculating the depreciation expense for property, plant and equipment (PPE). Straight-line depreciation is probably the most widely used. Straight-line depreciation applies the same amount of depreciation expense for every period.
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Determine the cost of the asset. In accounting, the historical cost principle is used to determine the cost of the asset, meaning that the asset is recorded on the books for whatever the cost was to acquire the asset (including additional costs that were involved in acquiring the asset such as legal fees, shipping fees and costs to prepare the asset for use).
Determine the expected salvage value and the useful life of the asset. The salvage value refers to residual or scrap value of the asset at the end of its useful life (in certain cases it can even be zero). These are often subjective measurements that may involve looking at similar assets to get a fair estimate. Typical measurements for useful life include five years and 10 years.
Calculate the depreciation expense by subtracting the salvage value from the cost of the asset. Then divide this amount by the estimated useful life. For example, if an asset cost £6,500 with a salvage value of £1,300 and a five-year useful life, then the calculation for depreciation expense will be:
($10,000 - £1,300) = £5,200 / 5 years = £1,040
Tips and warnings
- Land has an unlimited useful life.
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