20062023 Editorials STARTUPJARGON02:
- What are must-to-know STARTUP Jargon
- Why is Depreciation calculated
- What is the Depreciation period
- How should we calculate Depreciation, in our book of accounts
- Do you know the different methods for calculating Depreciation
Most of us know that the monetary value of equipment, mostly, decreases as the years roll by. This is mainly due to the technology enhancements, post buying and the wear and tear of the equipment. The financial wizards called this phenomenon of calculating this book loss DEPRECIATION. However, there are external factors also that cause depreciation like market trends.
Stalwarts believe that the word depreciation in the book of accounts has its own positives and negatives. To handle this deftly, it is mandatory to book profits for investors. Hence depreciation must be calculated in a precise manner.
‘Define Depreciation: Depreciation is an accounting method used to allocate the cost of an asset over its useful life. It represents the gradual decrease in the value or usefulness of an asset as it gets older or as it is used in the normal course of business operations. Depreciation is primarily used for tangible assets, such as buildings, vehicles, machinery, and equipment.
When a company purchases a tangible asset, it typically expects to use it for multiple accounting periods to generate revenue. Instead of recognizing the full cost of the asset as an expense in the year of purchase, the cost is spread out over its estimated useful life through depreciation.
Depreciation expense is recorded on the company’s income statement and reduces its net income. It is also accumulated as accumulated depreciation on the balance sheet, reducing the carrying value of the asset over time. Let us now understand the various methods used to calculate depreciation.
Straight-line method: The cost of the asset is divided equally over its useful life. In each accounting period, an equal amount of depreciation expense is recognized.
Declining balance method: This method recognizes higher depreciation expense in the earlier years of an asset’s life and reduces the amount in subsequent years. It applies a fixed depreciation rate to the carrying value of the asset.
Units of production method: Depreciation expense is based on the actual usage or production of the asset. The total estimated units of production or hours of usage are divided into the asset’s cost to determine the depreciation per unit.
Depreciation is important for financial reporting purposes as it helps match the cost of using an asset with the revenue it generates over its useful life. It also provides a more accurate representation of a company’s profitability by allocating the cost of the asset over multiple periods, reflecting the wear and tear or obsolescence that occurs over time.’
‘For all those who are interested to know in detail about the financial terms used by your auditors, we decided to start a series on financial terminology education. OMG! That sounds a little complicated, let us simplify that as a series on STARTUP Jargon.
In this series, we shall give the meaning of the various words used by the auditors and ways to better the phase of the STARTUP. However, we request each of you consult your financial advisors before deciding your strategy.
Every setup has its own methodology of growth and no two organizations are similar. Ultimately it is every founder’s dream to turn into unicorns and the ecosystem wants to see more such enthusiastic achievers. So wishing you all the very best in your endeavour hope our today’s topic on Depreciation cleared your perplexity, at least to some extent, on the terminology.’
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