Cash Flow Statement At A Point Of Time Or Period What is Depreciation

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What is Depreciation

Depreciation (depn) is used to measure the decrease in an asset’s useful life in dollars. A measurement is an estimate because an asset may last longer than its estimated useful life or vice versa. Its purpose is to help a company better reflect the cost of using an asset (excluding maintenance costs) over the life of the asset. Without this measure, the company’s profit is reduced or even incurs a loss in the period the asset is acquired and reflects greater profitability in subsequent periods while the asset is still being used by the company.

Accumulated depreciation is the total decrease in the value of an asset since the purchase of the asset. Assuming you have an asset that you purchased for $9,000 and is estimated to have a useful life of 3 years. Two years have passed. So the total spend is two-thirds of the purchase value, or $6,000. This will allow you to calculate the book value or residual value of the asset. Continuing with our example, the book value would be $3,000 because the asset remained with an estimated useful life of one year.

After 3 years, you can continue to use the asset at “no cost”. You can continue to use the asset and your net profit (which is the amount after deducting cost of goods and operating expenses) would increase by the amount of depn. While this is not ideal, we are in a better position than recognizing the entire cost of the purchase in one year.

The most common depn method is a straight line. First, the asset’s useful life is estimated. The cost of the asset is then spread evenly (usually by months) over the life of the project and this would be the depn value. For most assets, there are already legally prescribed standards or recommendations regarding their useful life. Most companies just adopt these legal standards. For example, the general rule is that computers and computer peripherals are depreciated over a period of three years. Other depn methods include sum of year digits and double descending balance. The depn method to adopt for a particular asset is usually determined by how its value changes over time.

Depreciation can be a major contributor to a business’s profit and loss, especially for businesses that require large capital investments. For example, in a telecommunications company (telco), a huge investment is required in its telecommunications network before the telecommunications company can offer its services to customers. Once this network was deployed, the telco could use it for its services for many years. Therefore, it is important that the telecommunications company amortizes these costs over its lifetime so that the company can reflect the actual costs of providing the service to its customers. In this case, it is important that the business analyst of the telecommunications company, when establishing the business model, makes sure that the depn is calculated accurately, otherwise it can completely distort the profitability of the company.

Calculating depn is relatively easy in an Excel-based business model if you have a good understanding of Excel’s worksheet functions. You will only need to use some formula and one row to calculate depn instead of using a 36 column by 36 row table to calculate depn for an asset with a life of 3 years. Click this depreciation link to learn how!

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