Depreciation denotes decrease in the financially viable potential of an asset over its fruitful or functional life. In other words, depreciation is a decline or loss in value of an asset owing to age, wear, or market conditions. The issue of depreciation comes up often while approximating the worth of any asset.
Before we go into the details of depreciation and related accounting, let us first understand what asset denotes. According to definition, assets include all the entries in a balance sheet such as physical as well as insubstantial properties, cash, stock, inventories, property rights, and goodwill owned by an individual or business. In other words, assets are a monetary reserve that has the capability or prospective of offer benefits to any business in the future. For instance, the money used to buy the items included in accounting. Assets like office furnishings, equipment and even vehicles may be maintained in excellent and usable state for long, but finally they too need to be replaced.
Hence, depreciation accounting is a process of calculating the value of an asset over its estimated functional life. In other words, it is a formula whereby the value or other listed value of a permanent asset minus its approximate anticipated or fair market value at the end of its lease term, in case there is any, is allocated over the fairly accurate useful life of the asset in a methodical and coherent method. From this it is clear that depreciation accounting is actually the procedure of price allotment of an asset and not its appraisal. Normally, the bookkeepers maintain different and detached collected depreciation accounts for individual grouping of assets that are liable to devaluation. In a balance sheet, depreciation is recorded as a debit to express expenses owing to devaluation of an asset and recorded as a credit to express accrued depreciation in a profit and loss statement of a business. However, entering depreciation record in the balance sheet does not have any consequence on the assets or accountability because this does not entitle to making any kind of imbursement.
The amount recorded in the balance sheet as accrued of accumulated depreciation is basically the total amount of devaluation that has been claimed on an asset since it was acquired. Hence, the book value or carrying worth of any asset is the result of the original price of the asset minus the accrued depreciation. It may be mentioned here that when the income of a firm is calculated for taxation purposes, the Income Tax Act allows for paying a lesser amount of tax on income much on the lines of depreciation of an asset. This, in the Income Tax Act, is known as the capital cost allowance.
In order to undertake a breakdown of venture outlay one needs to work out the operations as well as the cash income from the sales to find out the cash flows following payment of taxes. While undertaking an investment analysis, it is also important to work out the reduction in the worth of a material property and how it is dealt with by the Income Tax Act. This will enable one to deduce the ceilings related to the permissible discount in income tax payment for the reduction of the worth of an asset against its capital expenditure.
The permissible rebate, also known as the capital cost allowances (CCA), is applicable against the income tax payable for each year. This denotes that the income tax generated each subsequent year will be lesser on account of the depreciation in the value of an asset every year. It may be mentioned here that the capital cost allowance or the CCA rebate stages are characterized through classes or categories. To do this, different categories of properties are defined in the statutes included in the Income Tax Act.
The capital cost allowance (CCA) is always worked out on the basis of a proportionate allotment with regards to the price of acquiring a property, which is also deemed to be the amended expenditure base. It may be noted here that while the majority of them are declining remainder calculations, the capital cost allowances on specific assets are decided on the basis of amortization or repayment of the purchase price or the fruitful life of an asset as mentioned in the principles offered in the by-laws. This is calculated with the help of a straight line technique. In the instance of a real estate property, its buying cost needs to be assigned between depreciable segment such as a building and paraphernalia and non-depreciable items like the land to set up the foundation for working out the capital cost allowances. In fact, the depreciable segments are subsequently dependent on the capital cost allowances (CCA). It is able to subtract the capital cost allowance from the income generated by a real estate property and consequently helps in getting some respite or shelter from the total due income tax payment.
It may be mentioned here that the income tax rebates obtained for capital cost allowances (CCA) are basically bookkeeping entries and in no way influence the routine or daily cash flows. They, however, do have a bearing on the income that is taxable and hence influence both: after taxes cash flow and after taxes sale proceeds. As a result, from an investor's viewpoint, the purpose of capital cost allowances (CCA) in association with interrelated tax computing is quite significant in studying the advantages of any venture property.
When dealing with the evaluation of any real estate, depreciation of devaluation denotes any reduction in the worth of a physical property owing to its physical wear and tear from aging, as well as the destruction or extermination of the asset's external appearance. In such cases, while working out the depreciation, property evaluators mainly depend on two viewpoints of the related asset. The appraisers calculate the accumulated depreciation while approximating the cost vis-à-vis the value of the real estate. On the other hand, while calculating the income vis-à-vis the value, they use the accumulations for devaluation.