Accountants use depreciation to expense the use of fixed assets. Depreciable fixed assets include vehicles, buildings, equipment and similar items. The start of every depreciation method is the calculation of depreciable basis. All methods require this starting point in order to create an accurate figure to expense each year that accurately represents an asset’s use.
Companies must record an accurate historical cost for all fixed assets. Costs included can be the acquisition cost, set up charges, freight or shipping and test-run costs. Once incurred, accountants will record the total cost into the general ledger asset account. This figure is also an asset’s historical basis.
A second piece needed to determine the minimum basis for depreciation is asset salvage value. Companies will need to determine each asset’s salvage value, which is the amount earned when selling completely used assets. An asset’s market value is typically the salvage value used for depreciable basis calculations. For example, a company can sell equipment for $10,000 at the end of 10 years. The equipment’s salvage value is then $10,000.
The minimum basis for depreciation is historical cost less salvage value. This figure — typically called depreciable basis — is the total dollar amount a company can depreciate for the entire asset life. Under straight-line depreciation, for example, accountants divide the depreciable base by the asset’s useful life. The result is an annual depreciation figure.
Not all depreciation methods use salvage value in the determination of minimum basis. Double-declining balance and sum-of-the-years’ digits are two methods that avoid this figure. The result is higher depreciable cost and more tax advantages. At the end of the asset’s life, companies can trash the asset as it is worthless.