Depreciation of Large Assets

In general, larger assets tend to cost more than smaller assets.

Large assets are generally capital-intensive assets that cost a great deal. The higher the cost of an asset, the higher the depreciation expense. However, a large asset with a long useful life, which is defined as the period of time in which an asset can generate revenue, can also have a lowered depreciation expense.

Depreciable Assets

Assets are the lifeblood of most organizations. Organizations use assets, physical or virtual, to generate income. Large assets like equipment usually have a useful life of more than one year; that is, they create value and income for the company over a certain period of years. Not all assets can be depreciated, only those with a useful life of more than one year.

Size vs. Useful Life

There are many different ways to depreciate an asset. There may be an assumption that the size of the asset dictates the price; therefore, large assets have a larger depreciation expense. The truth is that, no matter how large it is, the more years an asset provides value to the company, the more years it will be depreciated over its useful life, which can drastically reduce the annual depreciation expense.

Matching Principle

Assume you have purchased a $100,000 automatic car wash system. You can depreciate the cost of the asset over the life of the asset, so instead of reporting a net income of $500,000 you can report a net income of $590,000 if the depreciation expense is only $10,000 every year for the next 10 years instead of the full $100,000 in year 1. Accountants prefer depreciation, because it helps to conform to the matching principle, which strives to expense items in the same period in which the revenue is generated.

Tax Affect

While companies may purchase an asset with an outflow of cash, that outflow is not represented (fully) on the income statement and net income remains higher than it would be if the entire cost of the large asset was expensed in the year it was purchased. The higher the cost of the asset and the shorter the useful life of the asset, the more it will influence net income and taxes. That is, a higher net income results in higher taxes and vice versa.

References

• FinWeb: Assumptions Play a Large Role in Depreciation Methods