Role Of Depreciation In Financial Accounting
As a term depreciation in accounting is the process of allocating the cost of a capital asset over the period of its useful life. Depreciation takes into account the decrease in the service potential of capital assets invested in a business venture, resulting from such causes as physical wear and tear in ordinary use, deterioration by natural elements or obsolescence caused by technological changes. Basically depreciation is a loss in value in market price of a good always taking the time factor into account. Depreciation is a rate of change in value in an asset fixed or current compared to the present value of that asset.
Depreciation plays an important role in financial accounting. This approach helps managers monitor their fixed assets over a period of time.
To understand the role of depreciation in financial accounting, it is important to grasp what fixed assets are and how they relate to a business from an operational standpoint. Essentially fixed assets are necessary to keep operations going.
Fixed assets are valuable to a business because these are the types of assets which an organization will likely own for a period of years. These assets, sometimes referred to as Property, Plant and Equipment, are the ones that are significant investments and are used to serve or produce the items which keep the business selling.
Enter the accounting processes that configures depreciation. By assigning dollar values, depreciation is a way for businesses to allocate the cost of a fixed asset over its useful life. It is a non-cash expense that must be added because over time fixed assets are likely to break, wear out or become otherwise used up and unable to produce to capacity.
When this occurs it will negatively impact a company's ability to keep things moving. Consider a moving van company. If one van becomes unusable due to wear and tear, the interruption would delay the company from adding more customers to their schedules and less people would be served; this equates to less profitability.
However when managers have an idea at a glance of how old or used up a fixed asset is, they can begin to make replacement plans when time begins to come due for the item to be fully depreciated. In order to operate to capacity any business needs to monitor fixed assets because without them, ability to produce would experience limitations.
There are a few primary methods of depreciation that are accepted under generally accepted accounting principles (GAAP) and these are the straight line method, declining-balance method and units-of-activity method. Each one has pros and cons and individual businesses must ascertain which method is best for them.
The three primary factors involved when computing depreciation, no matter which method is chosen are original cost, useful life and the salvage value, if any exists. Using designated depreciation formulas (depending on the formula chosen from the methods mentioned above), managers can calculate how much depreciates each financial period.
Another important factor to keep in mind when understanding the role of depreciation is the process in financial accounting is a cost allocation process, and it does not reflect the true value of an item, although it can. Essentially the amount depreciating per fiscal period does not necessarily reflect the market value of a fixed asset. Some fixed assets may still be quite valuable to sell after their depreciative value has passed.
The approach to deprecation will vary from company to company, however as long as an approved and acceptable format is used, businesses can use this technique to help make decisions where fixed assets are concerned. No matter which form of depreciation is used, the end result is the same, what's different is the amounts claimed during each fiscal period over the fixed asset's useful life.
Depreciation is an important decision making tool when it comes to long-term assets. Managers can use these figures to help them make decisions for upgrades, replacements or repairs.
Depreciation plays an important role in financial accounting. This approach helps managers monitor their fixed assets over a period of time.
To understand the role of depreciation in financial accounting, it is important to grasp what fixed assets are and how they relate to a business from an operational standpoint. Essentially fixed assets are necessary to keep operations going.
Fixed assets are valuable to a business because these are the types of assets which an organization will likely own for a period of years. These assets, sometimes referred to as Property, Plant and Equipment, are the ones that are significant investments and are used to serve or produce the items which keep the business selling.
Enter the accounting processes that configures depreciation. By assigning dollar values, depreciation is a way for businesses to allocate the cost of a fixed asset over its useful life. It is a non-cash expense that must be added because over time fixed assets are likely to break, wear out or become otherwise used up and unable to produce to capacity.
When this occurs it will negatively impact a company's ability to keep things moving. Consider a moving van company. If one van becomes unusable due to wear and tear, the interruption would delay the company from adding more customers to their schedules and less people would be served; this equates to less profitability.
However when managers have an idea at a glance of how old or used up a fixed asset is, they can begin to make replacement plans when time begins to come due for the item to be fully depreciated. In order to operate to capacity any business needs to monitor fixed assets because without them, ability to produce would experience limitations.
There are a few primary methods of depreciation that are accepted under generally accepted accounting principles (GAAP) and these are the straight line method, declining-balance method and units-of-activity method. Each one has pros and cons and individual businesses must ascertain which method is best for them.
The three primary factors involved when computing depreciation, no matter which method is chosen are original cost, useful life and the salvage value, if any exists. Using designated depreciation formulas (depending on the formula chosen from the methods mentioned above), managers can calculate how much depreciates each financial period.
Another important factor to keep in mind when understanding the role of depreciation is the process in financial accounting is a cost allocation process, and it does not reflect the true value of an item, although it can. Essentially the amount depreciating per fiscal period does not necessarily reflect the market value of a fixed asset. Some fixed assets may still be quite valuable to sell after their depreciative value has passed.
The approach to deprecation will vary from company to company, however as long as an approved and acceptable format is used, businesses can use this technique to help make decisions where fixed assets are concerned. No matter which form of depreciation is used, the end result is the same, what's different is the amounts claimed during each fiscal period over the fixed asset's useful life.
Depreciation is an important decision making tool when it comes to long-term assets. Managers can use these figures to help them make decisions for upgrades, replacements or repairs.
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