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Equipment depreciation refers to the process by which equipment used for business purposes loses value over each year of its life span. This is an important concept for business owners to understand, as they are allowed to write off this loss of value each year for tax purposes. The amount of equipment depreciation each year depends on how many years the equipment is scheduled to be used and the method of depreciation used. Most commonly, depreciation is calculated using either the straight-line method or the declining balance method.
Many businesses rely on various pieces of equipment to operate on a daily basis, such as the machinery used in factories or the various tools used in construction. Each year that this equipment is in use, it loses a little bit of value, until it eventually reaches a point where it has little or no value to the business due to the wear and tear it has endured. The value lost is known as equipment depreciation, a concept by which businesses are able to offset that loss of value in tax write-offs.
Any piece of equipment used for business purposes for a period longer than a year is subject to equipment depreciation. This yearly amount lost is realized on tax returns as the depreciation expense and differs from the accumulated depreciation, which is recognized on a balance sheet as a running amount. For example, a piece of equipment that depreciates each year by $200 US Dollars (USD) will have a depreciation expense for that amount each year, but the accumulated depreciation will be $200 USD in the first year, $400 USD the next year, and so on.
The amount of equipment depreciation realized each year depends on the method of depreciation used. In the straight-line method, a piece of equipment depreciates the same amount each year, an amount reached by dividing the cost of the equipment by its life span. For example, if a piece of equipment is worth $500 USD at purchase and has a life span of five years, it would have a depreciation expense of $100 USD, or $500 USD divided by five.
Some businesses prefer to expense a piece of equipment most heavily in the year that it is bought, and the declining balance method of equipment depreciation allows this. In this method, a percentage rate of depreciation is applied to the balance of the original cost. Using the example above, if the depreciation rate is 50 percent, then the first year's depreciation expense will be $500 USD multiplied by 0.5, which yields $250 USD. The next year the balance of the cost would be down to $250 USD, or $500 USD minus $250 USD, and the 50 percent rate would then be applied to that amount to calculate the depreciation expense for year two.