The Financial Accounting Standards Board (FASB) creates the generally accepted accounting principles, or GAAPs, that govern accounting as practiced in the United States. Although the FASB is independent of the International Accounting Standards Board (IASB) and has not chosen to adopt its standards as other similar agencies across the world, their shared principles and objectives have resulted in similar decrees and rulings. As such, FASB methods of accounting for depreciation do not differ substantially from those used in other countries.
Amortization or depreciation, as it is sometimes still called, is the decrease in resell value of assets incurred as a side effect of their use in business operations. Under both FASB and IASB accounting rules, depreciation is recorded each month as an expense because of the matching principle. The matching principle states that expenses should be accounted for in the same time period as the revenues that their occurrence helped earn. Since depreciation happens as a result of assets being used in business operations, the matching principle demands that it be counted as an expense in each accounting time period.
Estimation of Depreciation
Accrual basis accounting permits a certain amount of estimation into its values; this is quite evident with depreciation. Determining the exact amount of depreciation incurred each month is almost impossible and thus impractical, requiring estimation to produce usable numbers. This is done through basing the resell values and useful lifespans of assets based on the resell numbers of similar assets in a used state. Once approximate salvage values and useful lifespans are determined, it is possible to estimate depreciation per month using various formulas.
Straight Line Method
Straight line method is the simplest and one of the most common depreciation methods permitted under both FASB and IASB rules. It subtracts the salvage value from the asset's worth to produce its residual value and then divides this over the number of periods in its useful lifespan to produce its depreciation per accounting time period. Straight line method is most suitable for assets that lost resell value in a consistent and continuous manner over time and while not admissible for income accounting, is widely used because of its simplicity.
Declining Balance Method
Declining balance method is a sort of catch-all term for a number of different depreciation methods with the same basis. It derives residual value in the same manner as straight line method but continues to track it period after period as it declines. This is done because depreciation expense per accounting time period in declining balance method is a percentage of the asset's residual value, with the depreciation expense in its last month of use being whatever is left over above and beyond salvage value. The differences in the declining balance methods come in the percentages used for different classes of assets. For example, motor vehicles often use high percentages due to their fast drop in resell value, sometimes even going as far as to doubling the percentage used in what is called a double declining balance method. Declining balance methods are the only one permitted under U.S. federal tax rules and specific regulations exist on what percentages to use for what assets.
Alan Li started writing in 2008 and has seen his work published in newsletters written for the Cecil Street Community Centre in Toronto. He is a graduate of the finance program at the University of Toronto with a Bachelor of Commerce and has additional accreditation from the Canadian Securities Institute.