Depreciation is an annual income tax deduction that reduces the amount of taxes a company pays. As an accounting technique, depreciation allows corporations to recover the cost of certain assets over their useful life by charting the decrease in the value of a company's tangible or fixed assets over time. Depreciation expense is the portion of the cost of an asset that has been depreciated for a single period, reflecting how much of its value was used up in that time. Depreciation expense appears on a company's income statement as a non-cash expense that reduces the company's net income.

For tax purposes, companies can treat depreciation expenses as tax deductions. By reducing the amount of earnings on which taxes are based (by reducing the value of these assets on a company's income statement), depreciation reduces the amount of taxes owed. The larger the depreciation expense is, the lower the 澳洲幸运5官方开奖结果体彩网:taxable income will be—and the lower a 澳洲幸运5官方开奖结果体彩网:company's tax bill will be, as a result. The smaller the depreciation exꦑp🧜ense, the higher the taxable income—and the higher the tax payments owed.

Depreciation can only be applied to tangible or fixed assets; tangible assets are any assets that have a physical form, including inventory, vehicles, furniture, or equipment. Fixed assets are a type of tangible asset; they are used for a long period in a company's operations, such as buildings and land.

Depreciation on an Income Statement

Depreciation expenses can be found on a company's income statement. It is recognized after all revenue, 澳洲幸运5官方开奖结果体彩网:cost of goods sold (COGS), and 澳洲幸运5官方开奖结果体彩网:operating expenses have been indicated and before 澳洲幸运5官方开奖结果体彩网:earnings before interest and taxes (EBIT), which is ultimately used to c𓆉alculate a company's tax expense.

The total amount of depreciation expenses is recognized as 澳洲幸运5官方开奖结果体彩网:accumulated depreciation on a company's balance sheet and is subtracted from the gross amount of fixed assets reported. The amount of 澳洲幸运5官方开奖结果体彩网:accumulated depreciation 🦂increases over time, as monthly depreciation expenses are charged against a comꦿpany's assets.

When the assets are eventually retired or sold, the accumulated depreciation amount on a company's balance sheet is reversed, removing the assets from its 澳洲幸运5官方开奖结果体彩网:financial statements.

Methods for Calculating Depreciation

There are four methods used for calculating depreciation: 澳洲幸运5官方开奖结果体彩网:Straight line basis (also called straight line depreciation), 澳洲幸运5官方开奖结果体彩网:declining balance, 澳洲幸运5官方开奖结果体彩网:units of production, and 澳洲幸运5官方开奖结果体彩网:sum-of-the-years’ digits.

Each method recognizes depreciation expenses differently, which changes the amount by which the depreciation expense reduces a company's taxable earnings—and, therefore, its taxes.

Straight Line Basis

Straight-line basis (also called straight-line depreciation) depreciates a fixed asset over its expected life. To use the straight-line method, a company must first identify the cost of the asset being depreciated, its expected 澳洲幸运5官方开奖结果体彩网:useful life, and its 澳洲幸运5官方开奖结果体彩网:salvage value. (Salvag🤡e value is the price an asset is expected to sell for at the end of its useful life.)

For example, suppose company A buys a productioღn machine for $50,000. The expected useful life is five years, and the salvage value is $5,000. The depreciation expense for the production machine is $9,000 per year (($50,000 - $5,000) ÷ 5).

Declining Balance

The declining balance method applies a higher depreciation rate ⛎in the earlier years of the useful life of an asset. To use the declining balance method, a company must first identify the cost of the asset, its expected useful life, its salvage value, and the rate of depreciation💞.

For example, suppose company B buys a fixed asset with a useful life of three years༺. The cost of the fixed asset is $5,000, the rate of depreciation is 50%, and the salvage value is $1,000.

To find the depreciation value for the first year, use this formula: (net 澳洲幸运5官方开奖结果体彩网:book value - salvage value) x (depreciation rate). The depreciatio༒n for year one is $2,000 ([$5000 - $1000] x 0.5). In year two, the depreciation is $1,000 ([$5000 - $2000 - $1000] x 0.5).

In the final year, the depreciation for the last year of the use⭕ful life is calculated with this formula: (net book value at the start of year three) - (estimated salvage value). In this case, the depreciation expense is $1,000 in the final year.

Units of Production

The 澳洲幸运5官方开奖结果体彩网:units of production method assigns an equal expense rate to each unit produced. This method is most useful when an asset's value lies in the number of units it produces—or in how much it's used—rath꧑er thanꦯ in its lifespan.

For example, suppose company B buys a fixed asset for $25,000. The salvage value is $500. It's estimated to produce 50,000 units over its life; it produced 5,000 units this year.

To find the depreciation value, use this formula: (asset cost - salvage value)/estimated units over the asset's life x actual units made. The depreciation for the accounting period is $2,450 (($25,000 - 500)/50,000 x 5,000 = $2,450.

This method wil🌱l produce results𒐪 that vary annually depending on the number of units made.

Sum-of-the-Years' Digits

The sum-of-the-years’ digits is an 澳洲幸运5官方开奖结果体彩网:accelerated depreciation method, which 𒁃means it assumes that an asset will lose most of its value inꦛ the first few years of use.

where a perce𝓡ntage is found using the sum of the years of an asset’s useful li🎃fe.

For example, company B buys a production machine for $10,000. It has a useful life of five years and a salvage value of $1,000. To calculate the depreciation value per year, first calculate the sum of the years' digits. In this case, it is 15 years or (1 + 2 + 3 + 4 + 5). The depreciable amount is $9,000 ($10,000 - $1,000).

In the first year, the multiplier is 5 ÷ 15, since there are five years left in the useful life. In the second year,🐓 the multiplier is 4 ÷ 15; in the third year, the multiplier is 3 ÷ 15; and so on. The depreciation value is $3,000 ([$10,000 - $1,000] x [(5 ÷ 15]). Use this method up until the salvage value.

The Bottom Line

Depreciation reduces the value of assets, such as real estate and machinery, on a company's balance sheet. As a result, the amount of earnings on which taxes are based is reduced. While the🌠re are multiple accounting methods for determining depreciation, these methods are typically industry-specific. The four depreciation methods include straight-line, ꦫdeclining balance, sum-of-the-years' digits, and units of production.