Book depreciation is calculated by company accountants to save money on taxes.
"Book depreciation" is an accounting term that refers to the decline in value of a capital good specifically for tax purposes. Depreciation of equipment values may be tax-deductible when the business calculates its taxable profits. Several equations exist to compute depreciation, but each uses the same general information.
Factors
In order to accurately measure depreciation, you need the asset's cost, estimated life, residual value (book value after full depreciation), and the method of depreciation and the date on which the asset went into service.
Asset Cost
Cost not only includes the price on the invoice, but any costs associated with procuring the asset, such as transportation or preparation. All these combine to determine the asset's true cost.
Asset Estimated Life
Estimated life is determined by the business' calculation of how long the asset will last or the amount of production expected before the asset expires. Estimated life may be measured in time-lengths (years, months, days, hours), units produced (for factory machines) or hours used.
Asset Residual Value
Residual value is the business' best estimate of how much the asset may recoup at the end of its useful life through sale or trade. The cost minus the residual value represents the depreciable base, an important number for calculating book depreciation.
Depreciation Methods
The straight-line method provides the easiest computation for an asset's depreciation: Divide the depreciable base by the number of years according to the asset's estimated life. This represents a yearly depreciation total; subtract that total each year. The units-of-production method involves dividing the depreciable base by the total estimated output over the asset's life. This represents the per-unit depreciation; subtract this amount each time a unit is produced. Declining-balance and sum-of-year's digits are accelerated methods that create higher depreciation for the first few years of the asset's life and taper off throughout the remainder.
Benefits
The book depreciation of an asset results in tax-deductible benefits that will save the company money. Since the IRS taxes companies based on annual profits, the book depreciation represents a financial loss for the company and can be subtracted from the profits pretax. The IRS must tax the adjusted profits, saving the company money yearly while protecting its investment.
