![]() ![]() We also know that the book value of the tractor should equal $8,000 after 10 years (this is its residual, or salvage, value). Using the straight-line method, we know that we will be creating a constant depreciation expense every year. At the end of this 10-year period, the farmer reckons he can sell the tractor on the used market for $8,000. For even more complex situations, a company could elect to use even more involved accounting methods like the hours-of-service depreciation method or the unit-of-production method.įor this example, let's assume that a farmer purchases a tractor for $25,000 that he expects will last him 10 years. The two most common accelerated depreciation methods are the double-declining method and the sum-of-year method. Taking more depreciation up front also has the advantage of reducing the company's tax liability, which can be a major factor in management's approach to its depreciation policy. In this case, the real-world reality of purchasing a vehicle is best represented with an accelerated depreciation schedule. As it ages though, the rate at which it loses value decreases. The moment the car is driven off the sales lot, it loses a large percentage of its value. This method makes sense logically in the context of, for example, an automobile. Accelerated depreciation allows a company to take a larger depreciation expense in the first few years after the asset is purchased and smaller amounts in later years. While simple enough, the straight-line method is not always the best choice. The wear and tear on the building's roof, for example, is likely to wear down equally in its second year as it is in its sixth or seventh year. This method is common for depreciating assets that gradually and consistently succumb to wear and tear over time. This method accounts for depreciation by taking the same amount as an expense each year over the asset's useful life. In the example below, we'll keep it simple and use the straight-line depreciation method. The method chosen will depend on the asset, the implications for the income statement, and a company's internal policies. There are numerous methods an accountant can use to calculate an asset's depreciation expense. Here's how.įirst, what depreciation method should be used? To calculate this capital expenditure depreciation expense, the company's accounting team must use the asset's purchase price, its useful life, and its residual value. This depreciation in the asset's value must be accounted for on the company's income statement and balance sheet to capture the loss in value over time as an expense and as a reduction in the asset's actual value. This is a normal phenomenon driven by wear and tear, obsolescence, and other factors. Over time, the value of a company's capital assets declines. ![]()
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