After total cost is computed, officials estimate the useful life based on company experience with similar assets in the past or other sources of information such as guidelines provided by the manufacturer. [2] In a similar fashion, officials arrive at an expected residual value—an estimate of the likely worth of the asset at the end of its useful life to the company. Because both life expectancy and residual value are no more than guesses, depreciation is simply a mechanically derived pattern that allocates the asset’s cost to expense over its expected years of use. To illustrate, assume a building is purchased by a company on January 1, Year One, for cash of $600,000. Based on experience with similar assets, officials believe that this structure will be worth only $30,000 at the end of an expected five-year life. U.S. does not require any specific computational method for determining the annual allocation of the asset’s cost to expense. Over fifty years ago, the Committee on Accounting Procedure (the authoritative body at the time) issued Accounting Research Bulletin 43 which stated that any method could be used to determine annual depreciation if done in a “systematic and rational manner.” This guidance remains in effect today.
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Consequently, a vast majority of reporting companies (including Wals) have chosen to adopt the straight-line method to assign the cost of property and equipment to expense over their useful lives. The estimated residual value is subtracted from cost to arrive at the asset’s depreciable base. This figure is then expensed evenly over the expected life. It is systematic and rational: Straightline depreciation allocates an equal expense to each period in which the asset is used to generate revenue.
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