Depreciation

• Depreciation is an accounting term used to claim a deduction for certain property, plant and equipment. When a fixed asset is purchased, the full price of the asset is not expensed on the income statement. Rather, it is capitalized on the balance sheet and expensed over a period of time or the life of the asset. Accountants do this because fixed assets are expected to help a company generate revenue for a long period of time and expensing it all in one year would violate the matching principle. The matching principle is one of the core accounting concepts and says that recognized revenues should have related expenses recognized with them. Depreciation is also used for income tax purposes.
  
  

Straight-Line Depreciation

• There are different ways to depreciate fixed assets and straight-line depreciation is one of them. It is calculated by taking the price paid for the asset divided by the useful life. That is the amount that will be deducted on the income statement for each year of the useful asset until there is no value of the asset left on the balance sheet. For example, a company buys a car for $20,000. The company determines that the useful life of the car is 10 years. The per year deduction will just be $20,000 divided by 10 for a total of $2,000. The company will take a $2,000 deduction on its income statement for 10 years until the value of the car on the balance sheet reaches zero.
  
  

IRS/GAAP

• The IRS and the GAAP allow for different depreciation schedules. The IRS generally requires companies to use the Modified Accelerated Cost Recovery System (MACRS) for depreciation while GAAP allows for more flexibility and lets the company choose one of several available depreciation systems. A company does not have to use the same depreciation system for the IRS and for GAAP.
  
  

Medical Equipment

• Medical equipment is subject to the same rules and guidelines as other fixed assets. The IRS will require medical equipment to be depreciated on the MACRS schedule while GAAP will allow more flexibility for the depreciation system. Straight-line depreciation for medical equipment is not allowed under MACRS but is allowed under GAAP. Because a company has a choice for depreciation under GAAP, it may choose a system that makes its earnings be more favorable. A system such as MACRS will depress near term earnings because a bigger portion of the deprecation will be taken early in the life of the asset.