Depreciation in Accounting
From “The Profit and Loss Account in More Detail¨ in Accounting and Finance for Managers
Let us suppose that the estimated useful life of […] equipment is four years. It would be quite unfair to treat the whole of this €20,000 as a cost in the 1997/98 profit and loss account since the benefits of using the office equipment are estimated to last four years. Instead, the charge should be spread over this extended period using the process of depreciation.
Since the equipment in the example lasts for more than four years, it is a fixed asset (see 20241031165717-Components_of_a_Balance_Sheet). So, when there is a fixed asset on the balance sheet, then on the profit and loss account, so long as the benefits of using the fixed asset lasts for longer than the reporting period for which its historic cost would be enlisted, its historic cost should then instead be spread over the periods or the longer period within which its use will be of benefit (Kind 1999, 25). The way that this historic cost is spread over such periods, or such a longer period, of usage benefit is known as depreciation (Ibid).
Because depreciation occurs beyond the period of acquisition of the fixed asset, depreciation itself involves no cash (Kind 1999, 26). Despite its lack of cash flow, depreciation still acts as an operating expense in the profit and loss account due to its contribution to revenue generation (Ibid):
From “The Profit and Loss Account in More Detail¨ in Accounting and Finance for Managers
There are a number of important points to remember about depreciation. First, no cash is involved. […) Second, even though the […] depreciation charge does not involve any cash outflow, it is as much a part of […] operating costs as advertising and salaries.
Consequently, on the balance sheet for each financial period, the historic cost of the fixed asset will be subtracted by the accumulated depreciation until the accumulated depreciation is at or above that historic cost (Kind 1999, 26), e.g.:
From “The Profit and Loss Account in More Detail¨ in Accounting and Finance for Managers
The amount shown in the balance sheet will be the cost of the office equipment less than the amount of the accumulated depreciation at the end of the relevant financial year.
Fixed asset value is its cost of acquisition minus accumulated depreciation at end of year
Wherein is fixed asset value, is accumulated depreciation, and is historic expense for acquiring the good(s) underlying the fixed asset:
The difference between the fixed asset’s historic cost and its accumulated depreciation, while reflecting the value of the fixed asset for the firm or household, does not reflect its value to or for the market. That is (Kind 1999, 27):
From “The Profit and Loss Account in More Detail¨ in Accounting and Finance for Managers
In the case of a fixed asset successfully being sold, wherein its market value rather than historic cost make the difference, the profit derived from the sale can be enlisted separately under the profit and loss account or “deducted from the depreciation charge of the other assets¨ (Ibid).
Origins of depreciation for marginalists v. Marxians
Regardless of how we wish to describe it, however, the concept of depreciation is paradoxical at first glance: the measurement of depreciation, i.e. the resulting price, is the price of the equipment so long as it is not on sale, i.e. not in the market.
While this sounds paradoxical, it is not insofar as the net price based on the depreciation for the office equipment is based on a past sale or past availability in a market, and not present or future market presence (or present or future selling). What is created in doing this sort of accounting is an imaginary model of a closed/isolated market system for the interior of the firm or household, wherein no circulation of commodities (i.e., no exchange) takes place.
Under a marginalist approach, since the equipment engages in no circulation and it was acquired via exchange, the supply of any given unit of office equipment can be taken as inelastic while the demand can be treated as either nonexistent or decreasing over time. Insofar as the office equipment is used frequently, but its useful life is limited and it cannot be reproduced internally, one can treat the demand as decreasing over time. Of course, no circulation means no pricing to begin with, such that the conditions of supply or demand have no analytical relationship to any price in this scenario. However, insofar as the firm or household absorb the market price paid for the equipment as cost, the cost can be treated as the initial price inside the household or firm. It is easy to prove in this way that the interaction between the inside of a firm or household and the market leads to a kind of virtual phenomena known as depreciation, i.e. a decrement on the subjective value of the office equipment for the firm or household. This is, of course, different from the intersubjective value that office equipment has in being in that firm or household.
Under a Marxian classical approach, since the equipment is not actively proposed for exchange in actuality but was acquired by exchange previously, the equipment has no exchange-value but instead now has use-value. However, a use-value can still be a form of value, i.e. a crystallization of socially-necessary concrete labor skill and average socially-necessary abstract labor-time. Consequently, it could still be expressed in terms of an exchange-value, i.e. in terms of how much it can fetch. There is the speculative, prospective exchange-value, such as in an attempt to sell. There is also the speculative, retrospective exchange-value recorded from the initial purchase of the wealth in the market, if it had been so acquired. Regarding the latter exchange-value, insofar as the consumption for the use-value that was acquired via exchange neither adds value to the use-value nor has that use-value itself produce value, then all consumption is simply a transference or transformation of the value of the use-value elsewhere. As a use-value can only be consumed as long as its useful lifespan, this means that the value of the use-value is so to speak “bleeding¨ or “leaking¨ out of it with its continued use up to the end of its life. That is, it depreciates. Insofar as the retrospective exchange-value accurately expressed the value of the commodity or commodities at the time of purchase, this process of depreciation can be modeled and then calculated despite the wealth not being in circulation. Ultimately, the decreasing value of the use-value as it is consumed is different from the speculative, prospective exchange-value it may have insofar as it has remained a social use-value, whereby the attempt at expressing its value is subjected to the current, newly normalized or institutionalized mode of production as well as the purpose of the renewed relations of production.
How depreciation is modeled, and therefore how it is calculated, depends on what one is trying to do. In this case, depreciation would be calculated, for example, not to find out the future price of a commodity that has a deflationary trend, but to track the impact of the initial purchase and its continued use on the revenue-generating or wealth-generating potential of the given firm or household. Fixed assets, after all, condition the long-term internal activities, commercial and otherwise, of the firm or household.
Depreciation can be calculated in several ways:
- The straight-line method, involving charging an equal installment of the historic cost of the fixed asset for each period of, or within the duration of, the usage benefit of that fixed asset (Kind 1999, 25)
- The residuals based method, involving charging an equal installment of an estimation of the residual value of the fixed asset for each period of, or within the duration of, the usage benefit of that fixed asset (Kind 1999, 27)
- The reducing balance method (Ibid)
- The sum of the digits method (Ibid)
historic_cost profit_and_loss_account profit_and_loss_statement balance_sheet cash_flow operating_expenses operating_costs fixed_asset net_book_value book_value market_value realizable_value NBV accounting_value marginalism marginalist_economics economics Marxian_economics subjective_theory_of_value labor_theory_of_value Marxian_labor_theory_of_value STV LTV Marxian_LTV abstract_labor concrete_labor social_necessity socially-necessary_labor-time average_socially-necessary_labor-time SNLT ASNLT mode_of_production relations_of_production straight-line_method residuals-based_method residuals_based_method residual_value reducing_balance_method sum_of_the_digits_method cash mathematics math difference mathematical_operator mathematical_operators subtraction subtraction_operator subtraction_operators math
bibliography
- “The Profit and Loss Account in More Detail.” In Accounting and Finance for Managers, 25–37. The Fast Track MBA Series. Dover, NH: PriceWaterhouseCoopers, 1999.