This article mentions the three important factors to consider when determining the amount of depreciation to be charged to the profit and loss account in respect of a particular asset.

1. Cost of the Asset

The cost of the asset includes the invoice price of the asset less any trade discount, in addition to all costs that were essential to bring the asset to a useable condition.

For example, if a machine is purchased for $10,000 with $2,000 in freight charges and $3,000 in installation charges, the cost of the machine for the purpose of depreciation should be taken as $15,000, (i.e., $10,000 + $2,000 + $3,000).

It should be noted that financial charges such as interest on money borrowed for the purchase of the asset should not be included in the cost of the asset.

2. Estimated Scrap Value

Scrap value is the residual or salvage value that is expected to be realized after the sale of an asset at the end of its useful life.

In determining the scrap value, the cost to be incurred in the disposal or removal of the asset should be deducted from the total realizable value.

3. Estimated Useful Life

Estimated useful life is also known as the economic life of the asset. It can be calculated in terms of years, months, hours, units of output, or other operating measures (e.g., kilometers in the case of a taxi or truck).

Frequently Asked Questions

What is the difference between Depreciation and amortization?

Depreciation is the process of allocating the cost or a portion of the cost of an asset over a period. Amortization, on the other hand, is an accounting method that allocates costs over a limited number of years—regardless of whether those costs are for finite expenditures such as rent and insurance premiums or intangible expenses.

What are the factors affecting the amount of Depreciation?

The three important factors to consider when determining the amount of Depreciation to be charged to the profit and loss account in respect of a particular asset are: (i) cost of the asset (ii) estimated scrap value (iii) estimated useful life

What is meant by the cost of assets?

The cost of the asset includes the invoice price of the asset less any trade discount, in addition to all costs that were essential to bring the asset to a useable condition.

What is meant by estimated scrap value?

Scrap value is the residual or Salvage Value that is expected to be realized after the sale of an asset at the end of its useful life. In determining the scrap value, the cost to be incurred in the disposal or removal of the asset should be deducted from the total realizable value.

What is meant by estimated useful life?

Estimated useful life is also known as the economic life of an asset. It can be calculated in terms of years, months, hours, units of output, or other operating measures (e.G., Kilometers in the case of a taxi or truck).

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

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