What is Depreciation?

Depreciation is defined as an accounting methodology which allows an organization to spread the cost of a fixed asset over the expected useful life of that asset. The cost of the fixed asset immediately comes out of the cash account of the organization and is entered as an asset for the organization. At the end of each period of the useful life of the asset a part of the cost is expensed. This amount is added to the accumulated depreciation for the asset. The net value of the asset on the books of the organization is the asset account less the accumulated depreciation account.

A fixed asset is considered depreciable if it will wear out or become obsolete over a period of years. The period of years is called the life or the useful life of the item. The life that is assigned to an item will depend on industry standards, management standards, and governmental regulations. Generally, depreciable items include buildings, manufacturing equipment, office equipment, and vehicles. Land is not considered a depreciable item as it does not wear out or become obsolete.

Some fixed assets may be expected to have a market value at the end of their useful life. This expected value is called the salvage value. Some organizations set this value on a per asset basis, some use a percentage of the purchase price, some assume that all assets will have zero salvage value, and some use a combination of these methods.

Organizations usually set a price at which a fixed asset is considered depreciable. Any asset purchased at less than the set price is immediately expensed. This eliminates the need to track every waste basket, stapler, hammer, wrench, desk lamp, etc. Some organizations set this as low as $100.00. Other organizations set it at $10,000.00 or more. Once this limit has been set it should be adhered to and should not be reset every year