The Depreciation of a Plant & Equipment

Depreciation is based on the usage of assets over time.

Depreciation refers to both the devaluation of assets as well as a type of write-off given to plant and equipment charges after purchase. The calculation used to determine the annual depreciation charge is also used to devalue the assets over time. The most commonly used depreciation method is referred to as the straight-line method.

Tax Depreciation

Depreciation is a form of write-off for tax purposes. It is meant for assets with large upfront costs, such as property, plant and equipment (PPE). Most companies want to report a lower net income to the IRS and a higher net income to their investors; however, it is against both financial and tax accounting standards to report two different net income amounts, so companies report net income as they report to the IRS, which is why depreciation, a non-cash expense, is included on the income statement.

Depreciation Variables

While depreciation is a non-cash expense, it allows the company to reduce net income by a portion of the total cost of the asset. The main three variables for determining the depreciation on plant and equipment are salvage value, useful life and original cost. The salvage value is the value of the asset at the end of its useful life; the useful life is the number of years the asset can provide or generate revenue for the business, and the original cost is the price paid for the plant and equipment.

Straight-line Method

The most common method for depreciation of plant and equipment is called the straight-line method. The straight-line method subtracts the salvage value of the asset from the original cost of the asset and then divides the answer by the useful life of the asset. In general, the higher the useful life of the asset, the longer it can be written off of net income and the smaller the expense will be.

Example

As an example, assume you have $120,000 in plant and equipment. The plant and equipment have a salvage value of $10,000, which was determined by obtaining an estimate from the local scrap yard. The original cost of the plant and equipment is $100,000, even though it was appraised at $120,000, because you only depreciate at $100,000 -- the price you paid for it. If the seller of the plant and equipment says it has a useful life of 10 years, the annual depreciation expense is $100,000 minus $10,000 divided by 10, or $9,000.

References

• Accounting Info: Depreciation Methods