The initially recorded amount (cost), estimated salvage value, anticipated usable life, and depreciation method are all important considerations in estimating yearly depreciation for a depreciable item.
Assets are usually valued at their purchase price, which is usually objectively determinable. However, in other circumstances, such as "basket purchases" and the selection of an implicit interest rate in asset buys under deferred-payment arrangements, cost assignment can be extremely subjective and involve a lot of judgment.
When an asset is sold or removed from service, the salvage value is the expected amount that a corporation will get. The estimate is based on speculation and is influenced by the asset's useful life.
Useful life is also a matter of opinion. It entails deciding on a "unit" of service life measurement and calculating the number of such units embedded in the asset based on the company's previous experience with similar assets. Units of this type can be measured in terms of time or activity (for example, years or machine hours). When choosing a life, choose the lowest (shorter) of the two options: physical or economic. Wear and tear and casualties are part of physical life; technical obsolescence and inadequacy are part of economic life.
Determining the depreciation method is usually a matter of judgment; however, as previously said, a technique may be implicit in the unit of service life specification. If the units are machine hours, for example, the technique is based on the number of machine-hours utilized throughout each period. The approach that will best measure the fraction of services that will expire each period should be chosen. Once a technique has been chosen, it may be objectively implemented using a formula that has been determined objectively.
