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byU Depreciation refers to two very different but related concepts:
the decline in value of assets (fair value depreciation), and
the allocation of the cost of assets to periods in which the assets are used (depreciation with the matching principle).
The former affects values of businesses and entities. The latter affects net income. Generally the cost is allocated, as depreciation expense, among the periods in which the asset is expected to be used. Such expense is recognized by businesses for financial reporting and tax purposes. Methods of computing depreciation may vary by asset for the same business. Methods and lives may be specified in accounting and/or tax rules in a country. Several standard methods of computing depreciation expense may be used, including fixed percentage, straight line, and declining balance methods. Depreciation expense generally begins when the asset is placed in service. Example: a depreciation expense of 100 per year for 5 years may be recognized for an asset costing 500.
In economics, depreciation is the gradual and permanent decrease in the economic value of the capital stock of a firm, nation or other entity, either through physical depreciation, obsolescence or changes in the demand for the services of the capital in question. If capital stock is C0 at the beginning of a period, investment is I and depreciation D, the capital stock at the end of the period, C1, is C0 + I - D.In determining the profits (net income) from an activity, the receipts from the activity must be reduced by appropriate costs. One such cost is the cost of assets used but not currently consumed in the activity.[1] Such costs must be allocated to the period of use. The cost of an asset so allocated is the difference between the amount paid for the asset and the amount expected to be received upon its disposition. Depreciation is any method of allocating such net cost to those periods expected to benefit from use of the asset. The asset is referred to as a depreciable asset. Depreciation is a method of allocation, not valuation.[2]
Any business or income producing activity[3] using tangible assets may incur costs related to those assets. Where the assets produce benefit in future periods, the costs must be deferred rather than treated as a current expense. The business then records depreciation expense as an allocation of such costs for financial reporting. The costs are allocated in a rational and systematic manner as depreciation expense to each period in which the asset is used, beginning when the asset is placed in service. Generally this involves four criteria:
cost of the asset,
expected salvage value, also known as residual value of the asset,
estimated useful life of the asset, and
a method of apportioning the cost over such life.[4]
[edit]Depreciable basis
Cost generally is the amount paid for the asset, including all costs related to acquisition.[5] In some countries or for some purposes, salvage value may be ignored. The rules of some countries specify lives and methods to be used for particular types of assets. However, in most countries the life is based on business experience, and the method may be chosen from one of several acceptable methods.