Help with accounting question?

Question

Explain the following:
Depreciation is a process of cost allocation, not valuation.

Answer 1

The process of depreciating an asset is to allocate the cost of that asset over its productive period. This is a significant estimate for accounting purposes. The majority of companies depreciate vehicles over 5 years, which basically means it is useful to them for 5 years. At the end of that 5 years, the vehicle will have been depreciated to a book value of zero. However, that vehicle still hasa fair market value as it could be sold or traded in for some amount of money. So the depreciated book value on the balance sheet is not a true reflection of fair market value.

Answer 2

If you buy an asset, like a computer, and charged its entire cost to expense in the first month you bought it, it would make the income statement for that month worse....net income would be reduced by the $1500 price of the computer. that's not really an accurate reflection of the situation.

The real situation is that the company purchased an asset that has a useful life of five years. So depreciation is a way to take the cost of an asset and spread it over the useful life. If the company takes the $1500 cost of the computer and spreads it over 60 months, that's only 25 per month. That's a much better reflection of what's happening. Certainly the computer does its work over and over every month.

P.S. Depreciation allocates the cost over time, it has nothing to do with the market value of the asset. It doesn't matter if the asset grows in value in the market place, we are just allocating cost to the period in which the asset was used.

Answer 3

depreciation allocates a cost to a fixed asset over time.