Depriciation

Depreciation is a non-cash expense that reduces the value of an asset over time. Assets depreciate for two reasons:

Wear and tear. For example, an auto will decrease in value because of the mileage, wear on tires, and other factors related to the use of the vehicle.

Obsolescence. Assets also decrease in value as they are replaced by newer models. Last year's car model is less valuable because there is a newer model in the marketplace.

Depreciation is calculated as follows:

The original cost of the asset, including costs of acquiring the asset, transporting it, and setting it up

Less the salvage value (the "scrap" value)

Divided over the years of useful life of the asset.

Accumulated depreciation

While depreciation expense is recorded on the income statement of a business, its impact is generally recorded in a separate account and disclosed on the balance sheet as accumulated depreciation, under fixed assets, according to most accounting principles. Accumulated depreciation is known as a contra account, because it separately shows a negative amount that is directly associated with another account.

Tax depreciation

Most income tax systems allow a tax deduction for recovery of the cost of assets used in a business or for the production of income. Such deductions are allowed for individuals and companies. Where the assets are consumed currently, the cost may be deducted currently as an expense or treated as part of cost of goods sold.

Capital allowances

A common system is to allow a fixed percentage of the cost of depreciable assets to be deducted each year. This is often referred to as a capital allowance.