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  Depreciation

Introduction to Depreciation

The expense of depreciation that appeared in the income statement needs additional explanation. Most non-current assets do not contain a perpetual existence. They are ultimately used up in the process of producing revenue for the business. Basically, depreciation is an effort to calculated that portion of the cost (or fair value) of a non-current asset which has been used up in generating the revenue identified during a specific period. The depreciation charge is referred to be an expense of the period to that it relates. Depreciation tends to be appropriate both to tangible noncurrent assets (equipment and property, plant) and to intangible non-current assets.

We should be comprehensible that the principle is similar for both types of non-current asset. We shall deal with each of the two in turn. Depreciating tangible non-current assets (property, plant and equipment) to compute a depreciation charge for a period, 4 issues have to be considered:

  • the cost (or fair value) of the asset
  • the useful life of the asset
  • the residual value of the asset
  • the depreciation method.

The cost (or fair value) of the asset

The cost of an asset will involve all costs acquired through the business to bring the asset to its required location and to make it prepared for use. So, in addition to the costs of obtaining the asset, any delivery costs, installation costs (for instance, setting up a new machine) and legal costs acquired in the transfer of legal title (for instance, in purchasing property) will be involved as part of the total cost of the asset.

Likewise, any costs acquired in enhancing or altering an asset in order to make it appropriate for its intended use in the business will also be involved as part of the total cost.

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