Elements of Depreciation Computation

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ELEMENTS OF DEPRECIATION COMPUTATION

Depreciation accounting may be defined as a systematic procedure for allocating the cost of a long-lived asset over its useful life. The determination of the depreciation expense of a period depends on three basic elements. These are:

Depreciation Base. The cost to be allocated over the period of use is known as the depreciation base. This consists of the initial purchase cost of the asset minus any salvage value expected at the time of retirement plus the anticipated costs of removing the asset when it is retired. The cost of using an asset during its life is reduced by any salvage value recoverable at the end of the period and is increased by costs of removal. These elements of the depreciation base are often extremely difficult to measure. When it is anticipated that a substantial residual value will be recovered, an estimate of this value should be included in the determination of the depreciation base.

Useful Life. The useful life of a fixed asset is a function not only of the physical wear and exhaustion to which the asset is subjected, but also of technological change and innovation. Thus, a particular machine might be expected to last for ten years on the basis of physical endurance alone, but the development of new and better machines might reduce our expectation of its economic usefulness to four years. Both obsolescence and physical endurance must be considered in estimating useful life. In general, the useful life to be used for depreciation purposes will be the shorter of the lives estimated on the two bases. An asset that is physically exhausted can be expected to be replaced, even though it is not yet obsolete. On the other hand, an asset that is obsolete should also be replaced even though it is not physically worn out. •Procedures for Computing Depreciation. The objective of depreciation accounting is to assign to expense systematically the cost of a long-lived asset over the asset’s useful...
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