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Depreciating
Assets And Your Credit
What is a depreciating asset?
A depreciating asset is an asset with a limited effective life and can
reasonably be expected to decline in value over the time it is used.
Depreciating assets include such items as computers, electric tools, furniture
and motor vehicles. Land and items of trading stock are specifically excluded
from the definition of depreciating asset due to the fact that. Any improvements
to the land are also considered depreciating, such as a windmill or a fence, and
thus are not monitored with the land, even if they aren’t removable.
Most intangible assets are also excluded from the definition of depreciating
asset. Only the following intangible assets are specifically included as
depreciating assets:
- Certain items of intellectual property (patents, registered designs,
copyrights and licenses of these)
- Mining, quarrying or prospecting rights and information
- Certain indefeasible rights to use an international telecommunications
submarine cable system
- Spectrum licenses
- Data casting transmitter licenses.
The concept of depreciation is pretty simple. Depreciation is considered an
expense and is listed in an income statement under expenses. In addition to
vehicles that may be used in your business, you can depreciate office furniture,
office equipment, any buildings you own, and machinery you use to manufacture
products. To find the annual depreciation cost for your assets, you need to know
the initial cost of the assets. You also need to determine how many years you
think the assets will retain some value for your business. In the case of the
truck, it may only have a useful life of ten years before it wears out and loses
all value. Below are types of depreciating values.
Straight-line depreciation
Straight-line depreciation is considered the most common method of depreciating
assets. To compute the amount of annual depreciation expense using the
straight-line method requires two numbers: the initial cost of the asset and its
estimated useful life. For example, you purchase a truck for $20,000 and expect
it to have use in your business for ten years. Using the straight-line method
for determining depreciation, you would divide the initial cost of the truck by
its useful life.
The $20,000 becomes a depreciation expense that is reported on your income
statement under operation expenses at the end of each year.
For tax purposes, some accountants prefer to use other methods of accelerating
depreciation in order to record larger amounts of depreciation in the early
years of the asset to reduce tax bills as soon as possible.
You need, additionally, to check the regulations published by the federal
Internal Revenue Service and various state revenue authorities for any specific
rules regarding depreciation and methods of calculating depreciation for various
types of assets.
Physical Depreciation
Physical depreciation represents the accumulated loss in market value caused by
physical wear and tear since the date the building was completed. Physical
curable depreciation refers to damage that can be corrected economically, and it
includes such items as poor decorative conditions, broken fittings, outdated or
worn out carpeting, faded or old paint, appliances not in a proper working order
as well as aging roofs. On the other hand, physical incurable depreciation
includes wear and tear of structural members and foundations where repair or
replacement is likely to involve significant cost. These two kinds of
depreciation are treated differently. The dollar amount of the deduction
required for physical curable depreciation is generally based on the required
cost of carrying out the repairs. Conversely, the allowance for physical
incurable depreciation is more difficult to estimate, with the principal cause
of such difficulty lying in the determination of the remaining life of the
building.
There is no precise way to estimate the cost of correcting physical incurable
depreciation. The cost of this kind of corrections is so great that in terms of
economics the structure should either be left in its present state or totally
rebuilt. Governments tend to estimate the economic life of buildings in terms of
straight-line depreciation, but this is so merely because it makes the estimate
of capital gains and losses, as well as their recapture, a little easier to
determine from an accounting point of view. Appraisers and experienced Realtors,
on the other hand, will tend to make an educated guess more often than not as to
the value of the physical incurable depreciation based upon visual observation
while economists will base it upon knowledge of regional comparable market data.
Functional Depreciation
This type of depreciation describes the loss of value caused by outmoded or
inadequate design. Here too it is necessary to distinguish between curable and
incurable functional depreciation. Functional curable depreciation includes
items such as the cost of replacing old-fashioned fittings, installing an
additional bathroom or otherwise altering the existing plan by, for example,
creating new doorways and blocking old ones, or by following market trends such
as enhancing the visual appearance of rooms with open layouts and light-play.
Again, the amount by which market value is reduced is in direct function of the
cost involved in carrying out the necessary updates.
Moreover, like before, the amount by which market value is reduced because of
functional incurable depreciation is entirely a matter of judgment and cannot be
determined with an arithmetical calculation. There are, of course, limits to
what can be done to cure functional depreciation. For example, if an
architectural style has gone out of fashion, nothing can be done and a higher
factor of deduction will be applied. The opposite is true, of course, of plans
that never go out of style. For instance, residential ranchers are always high
on the list of demand and very much sought after by elderly and younger couples
alike but for opposing reasons: a lack of stairways for the first and easy
maintenance for the latter.
Overall, buying depreciating assets on credit is a highly negative thing. To buy
something that has a value that degrades over time would be a poor choice to add
to your credit as if you needed to sell it to regain the money to pay off the
amount, then you will be caught in a perpetual losing battle with debt.
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