What is depreciated cost?
– Depreciated cost is an accounting measure equal to an asset’s original purchase price (cost basis) minus all recorded depreciation to date. It represents the portion of the asset’s cost that has not yet been expensed on the books and is often used to show the asset’s carrying value in financial statements.
– Related labels you will see in practice: salvage value (residual amount expected at end of useful life), net book value (cost less accumulated depreciation), and adjusted cost basis (cost adjusted for depreciation and other adjustments).
How it works (plain language)
– Depreciation is an allocation: instead of expensing an asset’s full purchase price when bought, accounting rules spread that cost over the asset’s useful life so each period bears part of the cost.
– As a company records depreciation expense each period, accumulated depreciation grows and the depreciated cost (book value) falls.
– Depreciated cost is an accounting figure, not the same as the market price you could get selling the asset. Market value depends on supply and demand, condition, and other market factors.
– Management’s choices — estimated useful life, salvage value, and depreciation method — affect how fast the depreciated cost falls. Those choices are judgments that can make companies appear more or less “aggressive” in their expense recognition.
Key formulae
– Depreciated cost (book value) = Purchase price (cost basis) − Cumulative depreciation (CD)
– For straight-line depreciation:
– Annual depreciation = (Purchase price − Salvage value) / Useful life (years)
– Cumulative depreciation after t years = Annual depreciation × t
– Book value after t years = Purchase price − Cumulative depreciation
Step-by-step checklist (to compute or review depreciated cost)
1. Confirm cost basis: invoice price + taxes + necessary installation costs.
2. Estimate salvage value (residual value) at the end of useful life.
3. Choose a depreciation method (e.g., straight-line, declining-balance, units-of-production).
4. Estimate useful life in years (management judgment or industry guidance).
5. Calculate annual depreciation according to the chosen method.
6. Update cumulative depreciation (add each year’s depreciation).
7. Compute depreciated cost = cost basis − cumulative depreciation.
8. Disclose method and key assumptions in notes to the financial statements.
9. Periodically review useful life and salvage estimates for impairment or revised estimates.
Worked numeric example (straight-line)
– Facts:
– Purchase price (cost basis): $50,000
– Estimated salvage value at end of life: $5,000
– Useful life: 15 years
– Step 1 — total amount to depreciate = 50,000 − 5,000 = 45,000
– Step 2 —
Step 2 — annual depreciation = total amount to depreciate / useful life = 45,000 ÷ 15 = 3,000 per year.
Step 3 — produce a simple year-by-year schedule (straight-line, full-year convention)
– Year 1: Depreciation expense = 3,000; Cumulative depreciation = 3,000; Depreciated cost (book value) = 50,000 − 3,000 = 47,000
– Year 2: Depreciation expense = 3,000; Cumulative depreciation = 6,000; Depreciated cost = 44,000
– Year 3: Depreciation expense = 3,000; Cumulative depreciation = 9,000; Depreciated cost = 41,000
– Year 4: Depreciation expense = 3,000; Cumulative depreciation = 12,000; Depreciated cost = 38,000
– Year 5: Depreciation expense = 3,000; Cumulative depreciation = 15,000; Depreciated cost = 35,000
Terminal point (end of useful life)
– Year 15: Cumulative depreciation = 45,000; Depreciated cost = 50,000 − 45,000 = 5,000 (equals estimated salvage value).
Compact formulas
– Annual straight-line depreciation = (Cost − Salvage) ÷ Useful life
– Depreciated cost after t full years = Cost − (Annual depreciation × t)
Assumptions here: full-year convention (no pro rata partial-year calculation), salvage is not depreciated, no impairment or revisions to useful life.
Notes on variations and common adjustments
– Partial-year use: prorate the first and/or last year by the fraction of the year used (e.g., half-year convention = 0.5 × annual depreciation).
– Declining-balance methods (e.g., double-declining-balance) apply a constant rate to book value; they produce larger early charges and require switching to straight-line in later years if needed to avoid depreciating below salvage.
– Units-of-production: depreciation = (Cost − Salvage) × (Units used ÷ Total estimated units). Use when wear depends on usage, not time.
– Revisions and impairments: if useful life or salvage estimates change, recalculate future depreciation prospectively; if an asset’s recoverable amount falls below book value, record an impairment write-down per applicable accounting standards.
Quick checklist before you record depreciated cost
– Confirm cost basis (purchase price + capitalizable costs).
– Confirm salvage estimate and useful life (document rationale).
– Select and document the depreciation method and conventions (full year, half year, units).
– Apply formula, record annual depreciation, update cumulative depreciation and book value.
– Review periodically for changes or impairment.
Educational disclaimer
This explanation is educational and not individualized investment, tax, or accounting advice. For record-keeping, tax filings, or complex situations (component depreciation, tax-specific methods, or impairment testing), consult a qualified accountant or tax professional.
Sources
– Investopedia — Depreciated Cost: https://www.investopedia.com/terms/d/depreciatedcost.asp
– IRS, Publication 946 — How To Depreciate Property: https://www.irs.gov/publications/p946
– IFRS Foundation — IAS 16 Property, Plant and Equipment (standard overview): https://www.ifrs.org/issued-standards/list-of-standards/ias-16-property-plant-and-equipment/
– Financial Accounting Standards Board (FASB) — main site for U.S. GAAP guidance: https://www.fasb.org