Is Depreciation Fixed or Variable?
Senior corporate leaders pay attention to operating costs when running their businesses, focusing on variable costs that may significantly decrease net income over a period of time. Depreciation expense is on top management's agenda when a company is considering a new asset purchase because of depreciation implications on corporate profitability.
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Identification
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Depreciation is a process in which a company spreads the costs of its operating assets over several years. Depreciation expense is a fixed charge. Once a company determines the depreciation method applicable to an asset, the method remains in effect over the asset's useful life. Useful life refers to the number of years an economic resource will serve in the company's operating activities. Assets that are subject to accounting depreciation are long-term economic resources, such as plants, equipment, machinery, automobile and real estate.
Types
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Companies can depreciate operating assets with an accelerated or straight-line method. In an accelerated-depreciation method, an accounting supervisor allocates higher costs in earlier years and lower costs in later periods. In a straight-line method, the supervisor allocates the same amount every year. Examples of accelerated methods include double-declining-balance and Modified Asset Cost Recovery System, or MACRS. The IRS generally reviews a company's depreciation policies to ensure conformity with government guidelines.
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Depreciation Process
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Depreciation starts when a company purchases a fixed asset. A corporate accounting manager or fixed-asset reporting supervisor determines the useful life of the asset, based on corporate policies, industry practices and regulatory guidelines. For example, the Internal Revenue Service requires that organizations depreciate corporate cars over five years. The accounting manager will automatically apply the five-year rule to a new corporate car. After selecting the asset's useful life and depreciation method, the manager ensures that subordinates review depreciation entries when preparing financial statements.
Accounting and Financial Reporting
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To record depreciation expense, an accounting manager debits the depreciation expense account and credits the accumulated depreciation account. Given that depreciation expense is a fixed cost, most companies use accounting and financial management software to automate depreciation journal entries at the end of each month and quarter. As an operating expense, depreciation reduces net income and is listed on the Statement of Profit and Loss, also known as P&L or Statement of Income.
Considerations
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In addition to depreciation expense, organizations record asset-related expenses that do not involve cash disbursements. For example, amortization expense is a non-cash item that enables companies to spread the cost of intangible assets over several years. Intangible assets are corporate resources that lack physical substance, but serve in operating activities. Examples include patents and copyrights. Like depreciation expense, amortization charges decrease a company's net income and tax liability.
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