What is depreciation?

Essay by ridhaUniversity, Bachelor'sA-, November 2002

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Fixed assets are those assets of the business that have a long life, are used in the business and are not for re-sale or for conversion to cash, e.g. motor vehicles, machinery, buildings, land, office equipment, etc.

However, usually, except for land, most fixed assets have a limited number of years of useful life.

Depreciation can be defined, in its simplest terms, as the difference between the original cost of the asset and the amount received when the asset is sold, for example, if Pepe buys a motor vehicle for £ 20,000 and then sells it for £ 8,000, then the total depreciation is £ 12,000.

If an asset is bought and sold within one accounting period, (normally one trading year) then the depreciation can be accounted for within one accounting period.

However difficulties arise because most assets are used for more than one accounting period. Pepe is planning to keep his vehicle for four years.

In this instance there are two main methods of calculating the provision for depreciation, straight line and reducing balance. The choice of which method to use depends upon whether the main value to the business of the asset is gained evenly throughout the life of the asset or whether it is gained mainly in the early years of the asset when it is newer and the repairs and maintenance costs are lowest.