Depreciable cost
Depreciable cost is the amount of an asset's cost that will be depreciated. Depreciable cost equals acquisition cost less salvage value[1]. In order to determine depreciable cost, then, the contractor must first determine the estimated residual value for each of its assets or groups of assets.
The residual value need not be deducted from the capitalized cost in determining depreciable cost if:
- For tangible, personal property the estimated residual value does not exceed 10 percent of capitalized cost, or
- The contractor uses either the declining-balance method or the class life asset range system.
For example, if equipment has a cost of $30,000 but is expected to have a salvage value of $3,000 then the depreciable cost is $27,000[2][3].
Estimating allocation of depreciable cost basis
With cost data obtained and allocated between land and depreciable property, the estimated tax benefit for a study using the results of cost segregation studies previously conducted for similar properties can be calculated by estimating a reasonable allocation of depreciable cost basis to personal property, land improvements, and other asset classes. These averages are based on the actual results of previous studies conducted on various properties. Major commercial and residential property categories:
- apartments
- auto dealerships
- hotels
- manufacturing facilities
- office building
- shopping centers and malls
- warehouse properties
- flex buildings
A cost segregation study that uses the average asset class allocations to develop an estimate of the tax benefit shows results that are averages. Accordingly, the tax benefits of a cost segregation study for a given property might be either higher or lower than the average, depending on certain characteristics of each property category[4].
Factors in computing depreciation
Four factors affect the computation of depreciation[5]:
- Cost. Cost is the net purchase price of an asset plus all reasonable and necessary expenditures to get it in place and ready for use.
- Residual value. Residual value is the portion of an asset's acquisition cost that a company expects to recover when it disposes of the asset.
- Depreciable cost. Depreciable cost must be allocated over the useful life of the asset.
- Estimated useful life. Estimated useful life is the total number of service units expected from a long-term asset. Service units may be measured in terms of the years an asset is expected to be used, the units it is expected to produce, the miles it is expected to be driven, or similar measures.
Examples of Depreciable cost
- Land Improvements: Land improvements such as buildings, roads, bridges, and other structures that are built on land are subject to depreciation. The depreciable cost of land improvements includes the cost of construction and any associated costs.
- Equipment: Equipment such as machinery, tools, and vehicles can also be depreciated. The depreciable cost of equipment includes the cost of purchase and any associated costs.
- Technology and Software: Technology and software can also be depreciated. The depreciable cost of technology and software includes the cost of purchase and any associated costs.
- Furniture and Fixtures: Furniture and fixtures such as desks, chairs, and cabinets can also be depreciated. The depreciable cost of furniture and fixtures includes the cost of purchase and any associated costs.
Advantages of Depreciable cost
Depreciable cost can be a beneficial tool for businesses as it offers numerous advantages. These advantages include:
- Increased flexibility when calculating the cost of investments. By knowing the depreciable cost of an asset, businesses are able to accurately allocate funds and resources to those investments.
- Improved financial statement accuracy. By knowing the depreciable cost of an asset, businesses are able to accurately report the value of the asset on their financial statements.
- Improved tax planning. By knowing the depreciable cost of an asset, businesses are able to minimize their tax liabilities through appropriate depreciation schedules.
- Increased cash flow. Knowing the depreciable cost of an asset can help businesses determine when to sell the asset and maximize their after-tax cash flows.
Limitations of Depreciable cost
- Depreciable cost is only an estimated amount and can change based on the market and economic conditions. The depreciation rate and the amount of time over which the asset is depreciated can also affect the accuracy of the depreciable cost.
- Depreciation methods used to calculate depreciable cost do not accurately reflect the true cost of an asset. They are used for tax purposes and are not necessarily reflective of the actual cost of the asset.
- Depreciable cost does not take into account the cost of maintenance and repairs of the asset. These costs must be taken into account separately from the depreciable cost.
- Depreciable cost does not take into account the potential for an asset to appreciate in value over time. The asset may be worth more than its depreciable cost, but this can only be determined after the asset has been owned for some time.
In addition to determining the depreciable cost of assets, there are several other approaches that contractors must consider in order to properly account for their assets. These include:
- Accumulated Depreciation: This is the total amount of depreciation that has been taken on an asset since it was first placed into service. This is an important figure to consider when evaluating the current value of the asset.
- Depreciation Expense: This is the amount of depreciation that is expensed each period for an asset. This expense is recorded in the company's financial statements.
- Depletion: This is the process of allocating the cost of a non-renewable resource to the periods in which it is consumed.
- Amortization: This is the process of allocating the cost of intangible assets, such as goodwill, patents, and copyrights, to the periods in which they are consumed.
In conclusion, accurate calculation of depreciable cost is essential for proper asset management. Contractors should also consider other approaches, such as accumulated depreciation, depreciation expense, depletion, and amortization, in order to properly account for their assets.
Footnotes
| Depreciable cost — recommended articles |
| Sum of years digits method — Depreciation rate — Non-operating expense — Depreciation of fixed assets — Annual depreciation — Depletion expense — Going-concern value — Normal cost — Gross fixed assets |
References
- DiNardo P.G., Baldwin S.C., (2010), Practical Guide to Cost Segregation, CCH, Chicago.
- Heintz J.A., Parry R.W., (2016), Accounting, Cengage Learning, Mexico.
- Masoom K., (2013), The Entrepreneur’s Dictionary of Business and Financial, Partridge Publishing, Singapore.
- Needles B.E., Powers M., (2010), Principles of Accounting, Cengage Learning, New Delhi.
- Shim J.K., (2013), Dictionary of Accounting Terms, Simon and Schuster, New York.
Author: Natalia Hajduk
