Your business records depreciation to allocate the cost of assets over a period of time. This is in accordance with the belief that in due time, your asset loses its effectiveness and value due to several factors. However, it does not include extraordinary situations like fire, accident, or disaster. Depreciation is often employed to assess the value of properties of a company for tax purposes.
What causes depreciation?
1. Functional depreciation- as newer technologies are developed and growing demands are required of your asset, it might not be able to appropriately respond. Newer technologies might produce a better result than your old one, for the same or lower price. As a result, the value of the asset decreases.
2. Physical depreciation- applies to the normal wear and tear that happens as time goes by. Also, the older the asset becomes the more difficult and expensive it might be to operate it. This may be due to repairs done over the period of the asset’s life span.
Important factors in computing for depreciation
There are three important things to consider when you compute for the depreciation: the initial cost of the asset, the salvage value (if there’s any), and the useful life of the asset. Salvage value is the estimated value of the asset once it becomes fully depreciated. Getting the useful life (in years) of an asset might be difficult to determine without consulting some financial data; if in doubt, consult an accountant.
How is depreciation determined?
Various techniques may be used to determine your depreciation schedules. You can use a simple way like the straight-line depreciation method or the more complex ones like double-declining balance method and sum of the years’ digits method. Whatever method you choose, it’s always better to consult your accountant to determine the best technique to adapt in your business.
Why are depreciation schedules important?
Your business should operate legally, meaning, it should abide by the existing accounting standards and tax laws. Providing an allocation for depreciation in your financial reports ensures that you comply with the Generally Accepted Accounting Principles (GAAP). If you don’t accurately reflect depreciation, it might be tantamount to deceiving your investors in the true state of your business, and might cause a big problem if discovered.
As a legal business operator, you need to follow accounting standards no matter how complicated they may seem. To avoid making mistakes, get the services of an experienced accountant (or try purchasing some accounting software).
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