Accountancy Depreciation Concepts

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Questions and Answers

What does the term 'depreciation' refer to in accountancy?

The increase in the fair value of an asset

The allocation of the original cost of assets to periods in which they are used (correct)

An increase in the value of an asset over time

An actual reduction in the fair value of an asset

How does depreciation affect the balance sheet of a business or entity?

It decreases the net income (correct)

It increases the net income

It has no effect on the net income

It increases the fair value of the assets

Why do businesses depreciate long-term assets?

To increase their tax liability

To decrease their tax liability (correct)

To have no effect on their tax liability

To avoid reporting net income

How is the cost of a tangible asset allocated in accounting statements?

As depreciation expense among the periods in which the asset is expected to be used Signup and view all the answers

What is the impact of depreciating an asset on the income statement?

It decreases the net income reported Signup and view all the answers

What is one of the purposes of allocating the original cost of assets to periods in which they are used?

To accurately match revenue with expenses Signup and view all the answers

What is depreciation?

A method of allocating the net cost of an asset to the periods in which the organization benefits from its use Signup and view all the answers

How is the depreciable basis generally calculated?

As the amount paid for the asset, including all costs related to acquiring and bringing the asset into use Signup and view all the answers

What criteria are involved in recording depreciation expense in financial reporting?

Cost, expected salvage value, estimated useful life, and method of apportioning cost Signup and view all the answers

What is an impairment charge in accounting?

A nonrecurring charge related to the unexpected decrease in fair value of an asset Signup and view all the answers

What is considered when determining impairment charges?

Unexpected decrease in fair value and change in manner of asset use Signup and view all the answers

What does the depreciable basis generally include?

All costs related to acquiring and bringing the asset into use Signup and view all the answers

What is generally not ignored when calculating depreciable basis in some countries or for some purposes?

Salvage value Signup and view all the answers

When are impairment charges recognized according to accounting rules?

When assets' carrying amount decreases unexpectedly Signup and view all the answers

What does depreciation determine about an asset's value in the balance sheet?

Value placed on the asset in the balance sheet Signup and view all the answers

What is included in recording depreciation expense?

Current period's allocation of costs related to assets Signup and view all the answers

Study Notes

Depreciation in Accountancy

Refers to the systematic allocation of the cost of a tangible asset over its useful life.
Affects the balance sheet by reducing the book value of assets, reflecting usage and wear over time.

Purpose of Depreciation

Businesses depreciate long-term assets to match expenses with revenue generated during the asset's use.
This allocation leads to a more accurate financial picture, influencing investment and managerial decisions.

Cost Allocation in Accounting

Cost of tangible assets is allocated based on their expected lifespan and usage patterns.
This involves calculating a depreciable basis, which generally includes the purchase price plus any costs required to prepare the asset for use.

Impact on Income Statement

Depreciation expense reduces taxable income, benefiting cash flow by lowering tax obligations.
It reflects the expense associated with using an asset, impacting net profit.

Purpose of Cost Allocation

Allocating original costs to periods when assets are used ensures that financial statements reflect reality, assisting in better financial planning and analysis.

Depreciable Basis Calculation

Typically includes acquisition cost, installation, and any other costs necessary to ready the asset for its intended use.
Some costs like taxes or shipping may also be included in specific contexts.

Recording Depreciation Expense

Involves consistent and systematic recognition of depreciation to comply with accounting rules.
Criteria for recording include the asset's useful life, usage, and method of depreciation chosen (e.g., straight-line, declining balance).

Impairment Charges

An impairment charge represents a reduction in the carrying amount of an asset when its market value falls below its book value.
Determining impairment involves assessing external factors (market conditions) and internal factors (asset performance).

Recognition of Impairment Charges

Recognized when indicators of impairment are present and measurable, in accordance with accounting standards.

Asset Value on Balance Sheet

Depreciation determines the carrying value of an asset, showing its reduced value as it ages and becomes less useful.

Elements in Recording Depreciation Expense

Includes the annual depreciation charge, adjustments for impairment, and any disposals of the asset.

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Description

Test your knowledge of the concepts of depreciation in accountancy, including the actual reduction in the fair value of assets and the allocation of original costs to periods of use. Understand the methods and principles related to depreciation in accounting.