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Abstract

Read the article below (depreciation) and write a 100150-word (MAXIMUM) abstract for the article, that is in 100-150 words summarise the content on the article by focusing on the key components of the article.

Article- Depreciation

The term depreciation refers to an accounting method used to allocate the cost of a tangible or physical asset over its useful life. Depreciation represents how much of an asset's value has been used. It allows companies to earn revenue from the assets they own by paying for them over a certain period of time. Because companies don't have to account for them entirely in the year the assets are purchased, the immediate cost of ownership is significantly reduced. Not accounting for depreciation can greatly affect a company's profits. Companies can also depreciate long-term assets for both tax and accounting purposes.

Assets such as machinery and equipment are expensive. Instead of realizing the entire cost of an asset in year one, companies can use depreciation to spread out the cost and match depreciation expenses to related revenues in the same reporting period. This allows a company to write off an asset's value over a period of time, notably its useful life.

Companies take depreciation regularly so they can move their assets' costs from their balance sheets to their income statements. When a company buys an asset, it records the transaction as a debit to increase an asset account on the balance sheet and a credit to reduce cash (or increase accounts payable), which is also on the balance sheet. Neither journal entry affects the income statement, where revenues and expenses are reported.

Depreciation is considered a non-cash charge because it doesn't represent an actual cash outflow. The entire cash outlay might be paid initially when an asset is purchased, but the expense is recorded incrementally for financial reporting purposes. That's because assets provide a benefit to the company over a lengthy period of time. But the depreciation charges still reduce a company's earnings, which is helpful for tax purposes.

The matching principle under generally accepted accounting principles (GAAP) is an accrual accounting concept that dictates that expenses must be matched to the same period in which the related revenue is generated. Depreciation helps to tie the cost of an asset with the benefit of its use over time. In other words, the incremental expense associated with using up the asset is also recorded for the asset that is put to use each year and generates revenue.

The total amount depreciated each year, which is represented as a percentage, is called the depreciation rate. For example, if a company had $100,000 in total depreciation over the asset's expected life, and the annual depreciation was $15,000. This means the rate would be 15% per year.

Different companies may set their own threshold amounts for when to begin depreciating a fixed asset or property, plant, and equipment (PP&E). For example, a small company may set a $500 threshold, over which it depreciates an asset. On the other hand, a larger company may set a $10,000 threshold, under which all purchases are expensed immediately.

There are several methods that accountants commonly use to depreciate capital assets and other revenue-generating assets. These are straight-line, declining balance, double-declining balance, sum-of-the-years' digits, and unit of production.

Using the straight-line method is the most basic way to record depreciation. It reports an equal depreciation expense each year throughout the entire useful life of the asset until the entire asset is depreciated to its salvage value. Let's assume that a company buys a machine at a cost of $5,000. The company decides on a salvage value of $1,000 and a useful life of five years. Based on these assumptions, the depreciable amount is $4,000 ($5,000 cost - $1,000 salvage value).The annual depreciation using the straight-line method is calculated by dividing the depreciable amount by the total number of years. In this case, it amounts to $800 per year ($4,000 / 5). This results in a depreciation rate of 20% ($800 / $4,000).

The declining balance method is an accelerated depreciation method. This method depreciates the machine at its straight-line depreciation percentage times its remaining depreciable amount each year. Because an asset's carrying value is higher in earlier years, the same percentage causes a larger depreciation expense amount in earlier years, declining each year. Using the straight-line example above, the machine costs $5,000, has a salvage value of $1,000, a five-year life, and is depreciated at 20% each year, so the expense is $800 in the first year ($4,000 depreciable amount x 20%), $640 in the second year (($4,000 - $800) x 20%), and so on.

The double-declining balance (DDB) method is another accelerated depreciation method. After taking the reciprocal of the useful life of the asset and doubling it, this rate is applied to the depreciable baseits book valuefor the remainder of the assets expected life. For example, an asset with a useful life of five years would have a reciprocal value of 1/5, or 20%. Double the rate, or 40%, is applied to the asset's current book value for depreciation. Although the rate remains constant, the dollar value will decrease over time because the rate is multiplied by a smaller depreciable base for each period.

The sum-of-the-years' digits (SYD) method also allows for accelerated depreciation. Start by combining all the digits of the expected life of the asset. For example, an asset with a five-year life would have a base of the sum of the digits one through five, or 1 + 2 + 3 + 4 + 5 = 15. In the first depreciation year, 5/15 of the depreciable base would be depreciated. In the second year, only 4/15 of the depreciable base would be depreciated. This continues until year five depreciates the remaining 1/15 of the base.

The unit of production method requires an estimate for the total units an asset will produce over its useful life. Depreciation expense is then calculated per year based on the number of units produced. This method also calculates depreciation expenses based on the depreciable amount.