What Effect Does Depreciation Have on the Calculation of the Rate of Return on Total Assets?

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Depreciation is both the phenomenon, and the procedure used to represent the phenomenon.
Depreciation is both the phenomenon, and the procedure used to represent the phenomenon. (Image: Comstock/Comstock/Getty Images)

The rate of return on total assets equals net income divided by total assets. Depreciation can influence the rate of return on total assets through both sides of that equation. It impacts net income through the depreciation expense calculated in each time period, and affects total assets by building up accumulated depreciation over time. The net change on the rate of return on total assets caused by depreciation depends on the exact amount of the depreciation expense and the accumulated depreciation incurred thus far.

Depreciation

Depreciation refers to an accounting procedure used to represent certain assets' decline in value incurred through both their usage in business operations and other unrelated causes. In each time period that makes up the assets' useful time spans, a portion of their value is deducted as a depreciation expense, then allocated to accumulated depreciation that represents total value lost thus far. This process lasts until an asset's usefulness ends and its depreciable value is exhausted.

Depreciation Expense

Depreciation expense is the value that the asset being depreciated is estimated to be losing in the specific time period in question. It impacts rate of return on total assets by affecting net income, which is equal to revenues minus expenses. Depending on the nature of the business and whether it owns a large number of depreciable assets, such as buildings and vehicles, depreciation expense can be a significant portion of its operating costs. The higher the depreciation expense, the lower the net income, and thus the lower the rate of return on total assets.

Accumulated Depreciation

Accumulated depreciation is, as its name indicates, the accumulation of all depreciation expenses charged on a single asset. Each depreciable asset has its own accumulated depreciation, which represents the portion of its value lost to depreciation thus far. Each asset's net value is equal to its original book value minus its accumulated depreciation, meaning that the higher the accumulated depreciation, the lower the total assets, and thus the higher the rate of return on total assets.

Return on Total Assets

Rate of return on total assets is equal to net income divided by total assets. It represents the efficiency with which the business uses its assets to produce profits. Depreciation's impact on this figure can be separated into its impact through depreciation expense, and its impact through accumulated depreciation -- each of which produces the opposite effect to the other. In general, though, the combined effects of depreciation are likely to produce a detrimental impact on the rate of return on total assets.

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