Countless love songs have reminded the world that nothing lasts forever. Few of them mention that this is as true of capital assets as of affairs of the heart, which is why accountants should write more love songs. Depreciation is accounting's way of recognizing that buildings, equipment, vehicles and other capital assets eventually deteriorate, break down and become obsolete. A fully depreciated asset can have an accounting value of zero, but that hardly means it's worthless.
When an item fully depreciates, the business has the option of continuing to use the item without taking any further deductions on it, or selling the item to purchase a new model.
Every asset has a useful life, which is an accounting estimate of how long that asset will last. When a business buys a truck for $50,000, it doesn't report a $50,000 expense up front. Instead, it puts the truck on its books as an asset worth $50,000. It then depreciates the asset over the course of its useful life. Depreciation involves two things: recording a portion of the asset's cost as an expense and reducing the value of the asset on the books. Say the company estimates that the truck has a useful life of 10 years and won't have any value at the end of that period. Under the most common accounting method, straight-line depreciation, the company would depreciate $5,000 a year. So in the first year, it reports a $5,000 expense and reduces the book value of the asset to $45,000. In the second year, it reports another $5,000 expense and reduces the book value to $40,000. This continues until the asset is fully depreciated. Assets get depreciated down to zero or to their salvage value, which is what the company thinks it could get for the asset at the end of its useful life.
Fully Depreciated Assets
It's common to see depreciation referred to as the decline in an asset's value due to wear and tear. This description may help people wrap their heads around the concept, but it isn't actually correct. Depreciation is about allocating the cost of an asset, not putting a value on it. The book value is just an accounting device (a trick, even); it's not the same as the market value. The truck mentioned earlier may have a book value of $45,000 after one year, but if the company chose to sell it, it might get only $35,000. After nine years, the book value might be $5,000, but maybe the company could get $10,000 for it. A fully depreciated asset may have a book value of zero or a salvage value of, say, $1,000, but the company might get more if it sold the asset.
Assets Still In Use
A business isn't required to get rid of an asset just because it reaches the end of its useful life -- that is, when it has been fully depreciated. If an asset is still in working order, the company is free to keep using it as long as it wants. It simply does so without reporting any more expense. In accounting terms, it's getting to use the asset for free from that point on. Of course, if the asset is still usable, it probably has some value, but that's irrelevant from the accounting standpoint. The company can't revalue or "write up" the book value of the asset. Capital assets can only decline in book value, never increase.
Disposal of the Asset
As faithful as that rusty old truck has been, at some point the company will want to get rid of it. When it does, it compares the proceeds from the sale (or the disposal cost) with the book value of the asset and reports either a gain or a loss. Say the fully depreciated truck has a book value of zero. If the company sells the truck for $1,500, it reports a gain of $1,500 on the sale. If it has to pay $100 to get a junkyard to take it, the company reports a $100 loss. Now say the truck has been fully depreciated to a salvage value of $1,000. If the company sells the truck for $1,500, it reports a $500 gain. If it has to pay a junkyard $100 to take it, it reports a $900 loss.
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