subject: The Use of Depreciation Expense and It's Alternatives [print this page] The Use of Depreciation Expense and It's Alternatives
Companies today are constantly trying to stay ahead of the competition by providing customers with the most up to date products and services. The only way for companies to stay current and innovative is to reinvest in themselves. These new and innovative products or services can range from a new delivery truck all the way up to a new and improved computer network. The one thing that many of these products and services have in common is that they are all different types of Depreciation expenses. There are a few different methods for calculating Depreciation expense based on a company's particular needs. Both methods allow the amount that is being depreciated to be spread out over the asset's cost minus its estimated salvage value, over the assets potential useful life cycle to the company.
Accounting depreciation allows for the cost of an asset to be spread out over the time period that it is actually used. The original cost of an investment or asset is going to be the prepaid cost of the benefits that will be received in the years to come. When the investment or asset is used up due to its operational needs, portions of the assets cost can be from the profits that have been generated through its actual use. The Depreciation expense procedure allows for an allocation of the assets cost to be divided over the years that the investment or assets benefits will be received by the company. Depreciation expense does not recognize changes in market value or any difference in the original price compared to the replacement cost of the investment or asset. Depreciation expenses can be determined in a few different patterns such as the Straight-line depreciation method or the Accelerated depreciation method. Both of these depreciation expenses do not directly affect cash or the actual value of an asset. The companies cash has already been affected when the actual asset or investment was purchased, even if it is still being paid for.
The Straight-line depreciation method is a calculation of periodic depreciation expense by dividing the amount to be depreciated by the number of periods over which the asset is to be depreciated. Basically the amount of depreciation expense is going to be divided out evenly over the number of years that the asset is being used. Many companies use the straight-line depreciation method because it allows companies to report higher net incomes because they are claiming lower depreciation expenses than other methods. Straight-line depreciation methods are usually used for book purposes. The formula for Straight-line depreciation is Annual depreciation expense = Cost Estimated Salvage Value/ Estimated useful life.
The Accelerated Depreciation method is a calculation that results in greater depreciation expense in the early periods of an assets life than in the later periods of its life. Basically the amount of depreciation expense is the early years of an assets life cycle than at the end of an assets life cycle. Companies use this method which reduces net income during assets most profitable years. When the assets is nearing the end of its life cycle the depreciation expense will be less to the company and ultimately more profitable. Accelerated depreciation methods are usually used for income tax purposes.
The Internal Revenue Code was changed in 1981 to allow the use of Accelerated Cost Recovery System (ACRS) for depreciable assets used after 1980. After 1981 some firms began using the ACRS method because it allowed for rapid write off patterns like the declining- balance method. The tax Reform Act of 1986 altered some ACRS provisions and has now been referred to as MACRS. The Modified Accelerated Cost Recovery System (MARS) method was developed by the Internal Revenue Code for calculating the depreciation deduction. This method allowed for recovery periods allowed for recovery periods to be lengthened as well as additional categories for classifying assets. The actual cost recovery periods were identified with more detail based on what type of assets they were and their class life.
Companies like to make decisions based on market research as well as forecasting, but that can be very difficult when dealing with cash flow from the current fiscal year. Depreciation expenses allow for these assets to be divided out evenly or at an accelerated pace based on the company's present needs.
When the depreciating asset is used up completely or disposed of, the asset itself as well as the accumulated depreciation can be taken off the balance sheet.
