Depreciation expenses are calculated by dividing the cost of an asset by the number of years a company expects to own it, explains CPA Mike Piper for The Oblivious Investor. Straight-line depreciation calculates the deprecation of assets until the end of their life expectancies; salvage value calculates depreciation until the year of sale.Continue Reading
With the use of depreciation, companies can spread the cost of capital investments over a period of years instead of subtracting the whole expense from the earnings of the year of purchase, explains Piper. For example, company A spends $5,000 on a new piece of machinery that is expected to last for five years. If the company plans to keep the asset for the full five years of its life expectancy, the company accounts for the expense at the rate of $1,000 per year for five years. In this scenario, the company records a $1,000 depreciation expense each year and the accumulated depreciation each year.
The accumulated depreciation is the sum of all the previous years' depreciation for that asset, notes Piper. If the company plans to sell the asset in three years, it calculates the salvage value of the asset, which is the projected value of the asset in three years. If this projected value is $2,000, the company records $1,000 of deprecation for the three years it owned the asset. When the asset is sold, the company records a gain if it receives more than $2,000 for the asset, and a loss if it sells the asset for less.Learn more about Financial Calculations