Q1: What is depreciation and why is it important?
Depreciation is the accounting method of allocating the cost of a tangible asset over its useful life. It represents how much of an asset's value has been used up over time. Depreciation is important for tax purposes, financial reporting, and understanding the true cost of owning assets.
Q2: What is the straight-line depreciation method?
Straight-line depreciation is the simplest method where the asset cost minus salvage value is divided equally over the useful life. Formula: Annual Depreciation = (Cost - Salvage Value) / Useful Life. This method provides consistent depreciation expense each year.
Q3: What is declining balance depreciation?
Declining balance depreciation applies a fixed depreciation rate to the asset's book value each year, resulting in higher depreciation in early years and lower in later years. Common rates are 150% or 200% (double-declining) of the straight-line rate. This method better matches actual asset usage patterns.
Q4: What is salvage value?
Salvage value (also called residual value or scrap value) is the estimated value of an asset at the end of its useful life. It represents what you expect to receive when you sell or dispose of the asset. If an asset has no salvage value, use $0.
Q5: How do I determine the useful life of an asset?
Useful life is the estimated period an asset will be productive or provide value. It depends on factors like asset type, usage intensity, maintenance, and technological obsolescence. Tax authorities often provide guidelines (e.g., computers: 5 years, vehicles: 5 years, buildings: 27.5-39 years).
Q6: What is the difference between book value and market value?
Book value is the asset's original cost minus accumulated depreciation (accounting value). Market value is what the asset could be sold for today (actual market price). Book value is used for accounting and tax purposes, while market value reflects current economic conditions.
Q7: Can I change depreciation methods?
Generally, you should use the same depreciation method consistently. Changing methods typically requires justification and may need approval from tax authorities or accounting standards. Once chosen, stick with the method for the asset's entire life unless there's a valid business reason to change.
Q8: How does depreciation affect taxes?
Depreciation is a non-cash expense that reduces taxable income. Higher depreciation means lower taxable income and lower taxes. However, tax depreciation rules may differ from accounting depreciation. Consult a tax professional for tax-specific depreciation calculations.