When a business acquires an asset to be used for more than one year, it
appears in the BS as a fixed asset.These assets are expected to be used by
the business for a number of years – this is called the useful economic life
(UEL). At the end of the asset’s UEL, it may have some residual value, for
example it may be able to be sold on as scrap. During the UEL, the value at
which the asset appears in the BS
is gradually reduced until it is equal to the
residual value at the end of the UEL. This reduction is called depreciation.
An application of the matching concept
The rationale for depreciating assets is not to reflect changes in their market
value over time. Depreciation is an application of the matching concept.15 It
aims to match the cost of buying the asset to the revenue or other benefits
generated by its use. You can also think of it as a measure of the use or
wearing out of the asset over time.
There are many methods that may be used to calculate depreciation. Ideally,
the method chosen should be the one which most closely matches the cost to
the pattern of benefits obtained. However, most businesses are content to use
one of two main methods, straight-line depreciation and reducing balance
depreciation. These methods will only give an approximation of the actual
pattern of use of the asset, however, the differences involved should be
immaterial.
Comments