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How does depreciation help to retain cash in a business for asset replacement?

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How does depreciation help to retain cash in a business for asset replacement?
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Financial and Management Accounting

Financial and Management Accounting

ISBN: 978-1292086590

7th edition

Authors: Pauline Weetman

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Depreciation of non-current assets is the process of allocating the cost of the asset over its useful life. The cost of the asset includes the purchase price, any additional costs incurred to bring the asset to its current condition and location, and any other costs that are directly attributable to the asset. The useful life of the asset is the period over which the asset is expected to be used by the company. To calculate the depreciation, companies use different methods such as straight-line, declining-balance, sum-of-the-years\'-digits, units-of-production, and group depreciation. The chosen method will depend on the type of asset, the company\'s accounting policies, and the accounting standards that are applicable. The straight-line method allocates an equal amount of the asset\'s cost over its useful life, while the declining-balance method calculates depreciation at a fixed rate, typically double the straight-line rate, but the amount of depreciation decreases over time. The sum-of-the-years\'-digits method is similar to the declining-balance method, but the rate of depreciation is calculated using a fraction that is based on the useful life of the asset. It\'s important to note that the depreciation expense will be recorded on the company\'s income statement and the accumulated depreciation will be recorded on the company\'s balance sheet. This will decrease the value of the asset on the balance sheet over time.

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