Depreciation: How Companies Recapture the Cost of a Long-Term Asset
Depreciation is how companies recapture the cost of a long-term asset. Through depreciation, companies transfer the asset’s cost from the balance sheet to the income statement over a period of time. The type of asset, its useful life and the depreciation method used determines the length of time. Since accumulated depreciation reduces the value of the asset on the balance sheet, accelerated depreciation impacts income statement and balance sheet-based financial ratios.
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Accelerated Depreciation
The Internal Revenue Service has specific rules regarding the method of depreciation used and how to apply it. The method that the IRS recommends or mandates as the depreciation method for most situations is the modified accelerated cost recovery system, or MACRS. With MACRS, the asset depreciates faster in the earlier years of its useful life. Another accelerated depreciation method is the double declining balance method.
Profit Margin
Profit margin is a financial ratio calculated from the income statement. The profit margin shows how much a company earned out of every dollar generated in revenue. When accountants use the term “profit margin,” they refer to net profit margin. The profit margin is calculated by dividing net profit, also called net income, by total sales. The accelerated rate of depreciation increases depreciation expense. The higher expense lowers the profit. Therefore, accelerated depreciation decreases the profit margin.
Return on Assets
Return on assets reveals the percentage of net profit that a company earned on its average asset balances during the year. It is calculated by dividing net income by the average total assets during the year. Accelerated depreciation decreases net income, but it also decreases the book value of assets. For example, say net income for the year is $200,000. Asset value at the beginning of
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Accelerated Depreciation
The Internal Revenue Service has specific rules regarding the method of depreciation used and how to apply it. The method that the IRS recommends or mandates as the depreciation method for most situations is the modified accelerated cost recovery system, or MACRS. With MACRS, the asset depreciates faster in the earlier years of its useful life. Another accelerated depreciation method is the double declining balance method.
Profit Margin
Profit margin is a financial ratio calculated from the income statement. The profit margin shows how much a company earned out of every dollar generated in revenue. When accountants use the term “profit margin,” they refer to net profit margin. The profit margin is calculated by dividing net profit, also called net income, by total sales. The accelerated rate of depreciation increases depreciation expense. The higher expense lowers the profit. Therefore, accelerated depreciation decreases the profit margin.
Return on Assets
Return on assets reveals the percentage of net profit that a company earned on its average asset balances during the year. It is calculated by dividing net income by the average total assets during the year. Accelerated depreciation decreases net income, but it also decreases the book value of assets. For example, say net income for the year is $200,000. Asset value at the beginning of