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Depreciation – in simple words

Depreciation – in simple words

Let's try to explain the essence of depreciation in simple language from the point of view of managing this process, and not the usual formulations and calculation formulas.

What is depreciation

Depreciation is the amount of depreciation of an object for a certain period of time in value equivalent, which in the process of calculation is distributed by types of products/services produced and included in its cost price.

The monthly amount of depreciation is determined based on:

  • the initial cost of the input fixed assets (or intangible assets) from which it is accrued
  • their service life

How the accrual object is formed

The cost of fixed assets is formed by accumulating costs during construction, installation and commissioning of the object.

To understand the very essence of depreciation and why it is formed in the production process, let's give a simple example.

The main means is a lathe, the cost of which at the time of its commissioning is formed by accumulating the following items of capital expenditures:

  • contract value of the machine itself
  • customs duties (if imported equipment)
  • construction and installation work on its installation and connection
  • power cables/lines
  • foundation, etc.

how the cost of the depreciated object is formed

All costs during the construction of this facility are accumulated (as the work is carried out) and from the moment it is put into operation (according to accounting, the statement on the 01 account is debited), by signing the relevant act, it begins to be amortized. The amount of monthly accrued depreciation (depreciation) during the operation of the facility should already be written off to the cost price. As depreciation increases, the residual value of fixed assets will decrease, and depreciation (accumulated depreciation) will increase.

The fundamental difference between depreciation and other types of costs

The peculiarity and the main difference between depreciation and other types of costs included in the cost price is that if such cost items as raw materials, energy, wages, services are directly dependent on their correspondent (supplier), then depreciation is indirect.

What does this mean!?

In order to carry out production activities, settlements with suppliers and employees in such positions as raw materials, energy, wages must be carried out in full of the resources written off to the cost price with a constant cycle for the resumption of the production process. What can not be said about depreciation.

For example, in order to produce 1 000 stools per month, it is necessary to purchase 70 m3 of wood, 2 000 kW of electricity, pay people 10 000 rubles (salary). All these figures are included in full in the cost of all stools. As they are sold (revenue is received), payments are made with suppliers / employees and the subsequent purchase of resources in the appropriate amount for the resumption of the next cycle (production of another 1000 stools).

But depreciation does not have such a strict calculation framework. If the introduced fixed assets were built at their own expense, then there will be no obligations to reimburse their cost at all. The depreciation that came in the revenue will determine the free cash of the organization. That's why depreciation is included in the net income of the organization when calculating its net cash flow.

That is, when producing a product, all costs are included in its cost price. As the product is sold, the incoming money is directed to cover the costs. Part of the funds received as compensation for depreciation costs remain at the disposal of the owner of the product. If the fixed assets from which depreciation is accrued were purchased for loans, then this part of the money, together with net profit, will be used to repay debts. If the fixed assets are own, then the amount of depreciation together with net profit remains at the disposal of the business owner. Based on this approach, depreciation is defined as an element of net income companies (organizations).

The choice of depreciation policy as the right management decision

Depending on the service life of the entered object, the amount of depreciation charges may fluctuate. Various types of depreciation policy can also be applied (linear, accelerated, etc.). The choice of one or another depreciation policy, from the point of view of management, should be made depending on the type of product, its life cycle and physical wear of the equipment being introduced.

It is not always an artificial extension of the service life of the equipment, to reduce the monthly depreciation amounts, there is a positive in order to obtain current profits. This may affect the subsequent price competitiveness of products (in subsequent periods), when the product will no longer be so attractive to the market, and the residual value of fixed assets will still be quite high (obsolete).

For example, if the service life of the introduced fixed assets of 500,000 rubles is determined in 10 years, then the amount of monthly depreciation deductions, with the linear method of accrual, will be 500 000/10/12 = 4 170 rubles. But we assume that in 5 years the product will become obsolete in its qualitative characteristics, taking into account the developing innovations in this segment and its price competitiveness will fall. In this case, it is more expedient to apply accelerated depreciation if there is a high price potential over the next five years, because after 5 years, the product may already be unprofitable due to the market drop in prices for it. Then the amount of depreciation deductions per month will be 500 000/5/12 = 8 333 rubles. and the residual value of fixed assets at the end of the fifth year will already be 0 rubles, which will reduce the burden on the cost price with the exclusion of this cost item (depreciation).

The principle of depreciation and accounting calculation

The calculation of depreciation charges in practice is carried out according to the following principle, based on the initial cost of the entered object and its depreciation rate (with a linear method).

tabular calculation of depreciation charges

In this case, accumulated depreciation (accumulated depreciation) and residual value are automatically calculated.

Depreciation noma (with the linear method) This is the annual interest rate, which determines the share of the write-off of the initial cost of the object for products/services for the year.

In this case, with a service life of 5 years, the annual depreciation rate will correspond to 20% (100 / 5 years). If the service life was 10 years, then the depreciation rate would correspond to 10% (100/10 years).

If we give in general terms the very principle of accounting for depreciation deductions (for example, one of the periods), then it would look like this in this case.

Credit 01 of the account in correspondence with the Debit 20 of the account (main production) = 100 000 rubles.

That is, we reduced the residual value of fixed assets at the beginning of 2025 by 100 000 rubles, and this amount was written off first for the main production (unfinished), and then by posting Credit 20 accounts to Debit 43 accounts for finished products. According to the checksum of the balance sheet asset, the total amount has not changed, it has simply been redistributed between the active accounts (account 01 and 43).

In accounting, there is also account 02 – "Depreciation of fixed assets". It is not a balance sheet, but is used only as an auxiliary for accounting for accumulated depreciation charges during the operation of fixed assets. The account is passive, which means that its increase (arrival) is carried out on a Loan. Therefore, when the active account 20 is debited (when depreciation charges fall on the cost of production) according to the liability in the same transaction, account 02 is credited. In fact, there is no great need to maintain the 02 account.

depreciation - transfer of the cost of fixed assets to products

All this suggests that the entire cost of fixed assets in the process of their operation is gradually transferred to the products (to its cost price), depending on the adopted depreciation policy at the enterprise. After that, the latter is sold, the proceeds go to the settlement account (Debit 51 accounts), and in it there is already the depreciation that we included in the cost price. That's how balance sheet parity is maintained, taking into account accounting approaches.

Depreciation – the essence of a simple – Something like that!

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