Understanding the Basics of Depreciation
What is Depreciation?
Not everything that we purchase will have or keep the original value it holds. Over time, phones get scratched, computers lose storage space, cars become slower, we can go on and on. In the end, the question is "what is it worth now?". And that brings us to what is depreciation? Depreciation is the decrease in value of a tangible or physical asset over a period of time. When it comes to intangible assets, it also goes for the same as patents and copyrights are also depreciable.
How to Calculate Depreciation?
We have the solution in three easy steps! Here's a video or follow these steps:
Determine the type of asset (real estate, machinery, computers)
Look up the Modified Accelerated Cost Recovery System (MACRS) life span of the asset type (here are a few examples)
Real Estate has a 27.5-year life
Machinery has a 5-year life (computers, cameras, etc)
Take the purchase price and divide it by the lifespan for the asset
Josh paid $30K for machinery that has a 5-year life
$30K/5 years = $6K/year
There are also depreciation calculators available for other preferred methods to calculate the depreciation expense.
Is Depreciation Important?
So, is it important? We're going to go with YES! The reason is that depreciation actually allows companies to recover the cost of an asset when purchased. The process allows companies to cover the total cost of an asset over its lifespan instead of immediately recovering the purchase cost. This allows companies to replace future assets using the appropriate amount of revenue (AssetPanda). But, yes not all assets are worth the time for depreciating. Items that may only last a couple of months or do not cost very much, do not apply to this method.
Here is a quick video on how to calculate depreciation in three easy steps.
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