Definition of Depreciation Expenses
Depreciation expense results when the purchase price of a fixed asset is reduced over time, or its useful life, by wear and tear. One of the methods used to calculate depreciation is the straight line method.
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Identification
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According to Moneyinstructor.com, examples of fixed assets are buildings, computers, furniture and automobiles. Land is a fixed asset but rarely does it depreciate in value; depreciation expense does not usually apply to land.
Function
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To calculate depreciation expense using the straight line method you take the purchase price of the fixed asset and subtract the residual value. This is the value the asset will have at the end of its useful life. This figure is divided by the number of years in its economic life.
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Significance
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As asset that cost $8,000 with a residual value of $2,000 and an economic useful life of 4 years will have a depreciation expense of $1,500 for each of the four years ($8,000 minus $2,000 equals $6,000 divided by 4). This is the amount that will be charged to profits each period.
Useful Life
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The economic useful life is the number of years an asset will be able to function and make a profit for the company.
Declining Balance
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Some companies use the declining balance method to calculate depreciation. Depreciation charges are higher in earlier years because the asset is more productive in earlier years. As time goes on the asset produces less.
Benefits
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The method of depreciation is usually matched with the type of asset. According to tutor2u.net, when an asset produces benefits evenly over it’s useful life the straight line method is the most beneficial. When an asset produces more benefits in its earlier years the declining balance method is the most useful.
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