Question

If a machine costs initially $$\$ 1,000,000,$$ lasts for 10 years, and has a scrap value of $$\$ 100,000$$ at the end of its lifetime, how much depreciation should be taken into account each year in the current accounts? And how is this

Short answer

The annual depreciation for the machine is $90,000 using the straight-line depreciation method.

Step-by-step solution

Determine the total depreciation

The total depreciation is the difference between the initial cost and the scrap value of the machine. Therefore, we have: Total Depreciation = Initial Cost - Scrap Value

Calculate the total depreciation

Using the given values, Total Depreciation = \(1,000,000 - \)100,000 = $900,000

Calculate the annual depreciation

As the machine lasts for 10 years, we will divide the total depreciation by the number of years to find the annual depreciation: Annual Depreciation = Total Depreciation / Lifetime

Determine the annual depreciation

Using the values, Annual Depreciation = \(900,000 / 10 = \)90,000 Thus, the depreciation that should be taken into account each year in the current accounts is $90,000.

Key concepts

Understanding Scrap Value

Scrap value, also known as salvage value, is the estimated residual amount that an asset is worth at the end of its useful life. This value plays a crucial role when calculating depreciation because it acts as a baseline for determining the total decrease in value the asset experiences over its lifetime. In practical terms, it's the amount you might expect to receive if you were to sell the asset at the end of its life for parts or recycling. For example, let's consider a machine costing $1,000,000. Its scrap value at the end of its useful life is anticipated to be $100,000. This scrap value is subtracted from the initial cost to assess how much the machine depreciates over time. The concept here is that while the machine loses a significant portion of its value as it's used, it doesn't lose all of it – hence, the scrap value remains.

Figuring Out Annual Depreciation

Annual depreciation is the amount by which the value of an asset decreases each year during its useful life. It allows businesses and individuals to spread the cost of the asset over several years rather than absorbing the entire expense in the year the asset is purchased. This not only helps in expense management but also aligns with tax strategies. The process to calculate annual depreciation is straightforward:

• First, compute the total depreciation by subtracting the scrap value from the initial cost of the asset.
• Then, divide the total depreciation by the asset's expected lifespan.

For our machine example: 1. Total depreciation is $900,000 (calculated as $1,000,000 initial cost minus $100,000 scrap value). 2. Dividing this total depreciation of $900,000 by the 10-year lifespan provides an annual depreciation of $90,000.

Calculating Total Depreciation

Total depreciation is a central concept used to gauge how much an asset’s value depletes from its initial price to its ending scrap value over a specific period. This calculation provides a full picture of the asset's depreciation and is critical to financial planning. To find total depreciation:

• Subtract the scrap value from the initial purchase price of the asset.
• This result reflects how much of the asset’s value will be consumed during its useful life.

In our example with the machine, the initial cost was $1,000,000, and the scrap value is $100,000. Total depreciation is therefore $900,000, meaning this is the entire amount that the machine will lose in value during its 10-year useful life span. Understanding this helps in deriving annual depreciation, which, in turn, aids in appropriately balancing books and making informed financial decisions.