How to Depreciate Multiple Year Capital Costs

Capital costs are the costs needed to bring a long-term asset to full operational status.

One of the most important rules in accrual basis accounting is the Matching Principle that requires expenses to be recorded in the same time periods as the revenues that their occurrence helped produce. Since assets lose value through their usage until their usefulness is exhausted, these value losses across the multiple time periods of their useful lifespans must be recorded as depreciation expense. Capital costs are the costs needed to bring certain long-term assets to operational status. In most cases, capital costs are added onto the asset's value to be depreciated across the asset's useful lifespan.

Instructions

1. Find out the asset's book value. Book value is the value of the asset that is recorded on the accounting ledger, and is most often its purchase cost since that is considered an accurate assessment of its fair value under most circumstances. Capital costs are added onto the purchase cost because such expenditures produce benefits across multiple time periods. For example, if a machine was purchased at $20,000 and then required $5,000 to be set up and readied for operation, that machine would be recorded as having a book value of $25,000.

2. Estimate the asset's useful lifespan and residual value upon disposal. Useful lifespan is the length of time that the asset is expected to remain useful in its intended purpose, and residual value is the sum that the asset can be expected to be sold off for once it becomes useless. In most cases, both parameters can be estimated by examining the details of similar assets being sold used on the open market, in particular the period of time they were used prior to being sold and the prices at which they are sold for. For example, if a machine similar to the one in Step 1 is sold used after 10 years for $5,000, it is reasonable to assume that the machine has a useful lifespan of 10 years and residual value upon disposal of $5,000.

3. Choose a depreciation method to be used in the asset's depreciation. Depreciation methods are mathematical formulas used to estimate the asset's value loss in each period in order to approximate the pattern of its actual value loss across its useful lifespan. Different assets are most suited to different depreciation methods, but the most popular methods are straight-line method and the numerous variations on the declining-balance method.

4. Calculate the asset's depreciation expense in each time period until its useful lifespan is at an end and its usefulness is exhausted.

   Using the straight-line method, the asset's value is depreciated in equal portions across its entire useful lifespan. For example, the machine has $20,000 of its $25,000 as depreciable due to residual value and is expected to last 10 years. As such, its depreciation expense for each year is $2,000 or $20,000 divided by 10.

   Using the declining-balance method, the asset's remaining depreciable value is depreciated a set percentage year after year. Different percentages are better suited to different classes of assets. For example using a 20 percent depreciation rate, the asset would be depreciated $4,000 in the first year, $3,200 in the second year, $2,560 in the third year and so on.

References

• IAS Plus: IAS 1, Presentation of Financial Statements
• IAS Plus: IAS 16, Property, Plant, and Equipment
• IAS Plus: IAS 18, Revenue