12 Depreciation

Depreciation

Allocation of the cost of a fixed asset over its useful life as an expense.

Fixed Assets

High-cost, long-life assets used in a business (e.g., equipment, machinery).

Acquisition Cost (C)

The initial purchase price of an asset.

Useful Life (N)

The expected number of years an asset will be used.

Residual/Salvage Value (R)

Estimated value of an asset at the end of its useful life.

Straight-Line Depreciation Method

Depreciation method assuming asset loses value evenly over its life; D = (C-R)/N.

Sum of Years’ Digits Method (SOYD)

Accelerated depreciation method; charges more expense in early years; D = (C-R) × (Remaining Life / Sum of Years Digits).

Double Declining Balance Method (DDB)

Accelerated depreciation method based on book value each year; D = Book Value × (2/N).

Book Value

Cost of asset minus accumulated depreciation.

Depreciation Expense

Amount of asset cost recognized as expense in a particular year.

Comparison of Depreciation Methods

SLM is consistent; SOYD & DDB front-load expense; all methods total the same over asset life.

Impact of Depreciation on Taxes

Accelerated methods reduce taxable income more in early years compared to SLM.

SLM Advantages

Simple, consistent, easy to calculate, commonly used for financial reporting.

Accelerated Methods Advantages

Match higher expense to higher utility/use in early years; may provide tax benefits.

Asset Examples

Pharmacy equipment like auto-dispense systems, refrigeration units, or counters.

Effect of Depreciation on Cash Flow

Does not affect cash directly but affects taxable income and net income.

Depreciation Accounting Purpose

Reflects the wear and tear of assets; matches cost with revenue earned from asset use.