Decline in market value of an asset due to deterioration of obsolescence.
Decline in value of an asset to its owner.
Systematic allocation of an asset’s cost over its useful of depreciable life.
We’ve considered how an asset begins with a certain cost, a market value, and how that asset may be sold for its salvage value. What we need to consider is how its value changes over time, in order to effectively consider the change in a firms assets over time. Thus, depreciation is described as the decline in market value or value in the owner’s eyes (which are synonymous) or how that asset’s cost is allocated over its useful life.
Expenses are part of regular business operations, sometimes recurringly. These losses in net assets are consumed over a short period of time, and thus do not lose value gradually over time, but rather are subtracted from business revenues as they occur. As such, they may be written off when they occur, reducing income taxes. Examples of expenses include labor, utilities, materials, insurance, etc. Critically, the value of an expense is consumed quickly, and so that loss is incorporated into the market value. As such, expenses cannot be depreciated.
Depreciation is used to account for costs due to capital assets losing value gradually over time. This loss of value is not written off at any instant, but rather written off or depreciated over its depreciable life or recovery period. This write off, like writing off an expense, reduces taxable income. These are non-cash costs, indeed they are the loss of value of capital assets such as buildings, plants, machines, etc.
| Revenue | Sales of products and services | 184 |
|---|---|---|
| Costs | Wages, materials, utilities | (110) |
| Depreciation | (35) | |
| Sales, admin, financing | (19) | |
| Net income | 20 | |
| Taxes | (7) | |
| Profit | 13 |
Requirements for Depreciability are as follows
Restrictions on Depreciation claims are as follows.