Depreciation

Question 1

Define depreciation

Answer 1

Depreciation is the systematic allocation of the historical cost of an asset, less its residual value, over its useful life.

Question 2

Why is depreciation an expense?

Answer 2

There is a depletion of an asset as it has been used to create future economic benefit. There is a decrease in equity due to a decrease in profit of the business. This transaction has not caused equity to decrease due to drawings of the owner.

Question 3

Why is depreciation a limitation of the financial statements?

Answer 3

Depreciation is only an estimate. It could be miscalculated because we can only estimate its residual value (selling price) and/or its useful life (years). The only thing certain is its historical cost.

Question 4

Does depreciation calculate the market value of an asset?

Answer 4

NO! It is an estimation of how much of an asset has been used up or worn out over its useful life when producing income for the business.