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Misconceptions About Depreciation in Financial Accounting
Two misconceptions frequently arise regarding depreciation. First, some people believe that depreciation is a valuation procedure. That is, they believe the book value that results from depreciation reflects an asset’s market value. It does not. Book value results from the application of a rather mechanical depreciation method. No attempt is made to estimate the current market value of an asset by surveying recent transactions.
Second, depreciation expense is alleged to be a source of cash. This misconception is due to the format of the statement of cash flows. Recall that under the indirect approach, depreciation expense is added to net income in calculating cash provided by operating activities. Depreciation expense is added, not because it is a source of cash, but because
- it was previously subtracted in determining net income and
- it does not involve a cash outflow.
Be especially careful not to fall into this “cash flow trap.” Depreciation, by itself, does not generate cash.
Depreciation Methods and Topics
- Straight-Line Method (Depreciation Methods)
- Sum-of-the-Years’-Digits Method (Depreciation Methods)
- Declining-Balance (DB) Methods (Depreciation Methods)
- Tax Depreciation
- Selection of Depreciation Method
- Misconceptions About Depreciation
Property, Plant, and Equipment (PPE) Topics
- Property, Plant and Equipment (PPE)
- Initial Valuation of Property, plant, and equipment (PPE)
- Depreciation of Property, plant, and equipment (PPE)
- Expenditures After Acquisition - Property, plant, and equipment (PPE)
- Disposals of Property, plant, and equipment (PPE)
- Write-Downs - Property, plant, and equipment (PPE)
- Financial Statement Presentation of Property, plant, and equipment (PPE)
- Utilization of Property, plant, and equipment (PPE)
- Percentage of PPE Depreciated (Age)
- Evaluation of the Accounting for Property, Plant, and Equipment (PPE)
Related Noncurrent Assets Topics
