Depreciation

The word "deprecation" in accounting and tax is normally referred to expensing a portion of fixed asset value (such as equipment, computer, furniture, and building). See, when a company purchases a computer for $1,000, this amount cannot be expensed entirely within a year. The reason is that the computer has value after the first year. For example, in the second year, a company can sell it for $500 (no zero value like other expenses such as utilities, rent, fees, etc.). That is why a company has to put it on its book for many years (not expensing it and also known as capitalizing a fixed asset) until the computer is either disposed of or sold in the future.

For financial accounting purposes, companies generally use a straight-line method to depreciate a fixed asset. For example, when a company buys a computer, this company usually adopts a capitalization policy to depreciate a computer for its estimated useful life. This can be three to five years. Once a company adopts a three-year depreciation policy over a computer, a depreciation expense is computed either monthly, quarterly or annually starting from the date of purchase. For example, a company buys a computer for $3,600 on 7/1/xx01 and has a three-year life policy for computers. For the year ended 12/31/xx01, the depreciation expense should be $600 ($3,600 divide by 3 years multiply by 1/2 year).

For tax purposes, the life and the depreciation method is generally different from the above example. Tax law dictates what life and what method should be used and the tax law is influenced by the economy policy adopted by the President of the U.S. and members of Congress.