Depreciated cost is the value of a fixed asset minus all the accumulated depreciation recorded against it. It’s a critical metric that can reveal trends in a company’s capital spending and the precision of their accounting methods. Essentially, it represents how much of the asset’s original value has been “used up.”
Depreciated cost is also known as the “salvage value,” “net book value,” or “adjusted cost basis.”
Key Insights:
- Definition: Depreciated cost is the value of a fixed asset minus accumulated depreciation.
- End-of-Life Evaluation: It measures an asset’s value after its useful life is complete.
- Financial Indicator: It helps companies evaluate their capital spending and accounting practices.
- Alternate Terms: Also referred to as “salvage value,” “net book value,” or “adjusted cost basis.”
How Depreciated Cost Works
The depreciated cost method is used to determine the reduced, useful value of an asset over time. Unlike market value, which fluctuates based on supply and demand, depreciated cost systematically reduces as depreciation expenses are recorded.
By keeping track of an asset’s depreciated cost, businesses can see the current value of their assets in their accounting records. This also helps measure the cash flows generated from the asset relative to its depreciated value.
The formula to calculate the depreciated cost is:
[
\text{Depreciated Cost} = \text{Purchase Price (or Cost Basis)} - \text{Cumulative Depreciation}
]
Where:
- Purchase Price (or Cost Basis): Initial cost of the asset.
- Cumulative Depreciation: Total depreciation recorded over the asset’s useful life.
Example of Depreciated Cost
Imagine a construction company has an inoperable crane that can be sold for parts for $5,000. This amount represents the crane’s depreciated cost or salvage value. If the crane was initially purchased for $50,000, the overall depreciation over its useful life would amount to $45,000 ($50,000 - $5,000).
Assume the crane has a 15-year useful life. The company can calculate the annual depreciation using the straight-line depreciation method, where depreciation is constant every year. Here, annual depreciation would be:
[
\text{Annual Depreciation} = \frac{\text{Total Depreciation}}{\text{Useful Life}} = \frac{45,000}{15} = 3,000
]
Thus, the crane depreciates by $3,000 each year until it reaches its salvage value of $5,000.
Related Terms: Accumulated Depreciation, Asset Valuation, Market Value, Cash Flow.
References
Get ready to put your knowledge to the test with this intriguing quiz!
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## What does "Depreciated Cost" refer to?
- [ ] The initial purchase cost of an asset
- [x] The value of an asset after accounting for accumulated depreciation
- [ ] The scrap value of an asset
- [ ] The cost to repair an asset
## Why is depreciated cost used in financial accounting?
- [x] To reflect the reduced value of an asset over time
- [ ] To increase the total value of assets
- [ ] To inflate net income
- [ ] To calculate tax deductions directly
## Depreciated cost is most relevant in which type of accounting?
- [x] Financial accounting
- [ ] Managerial accounting
- [ ] Cost accounting
- [ ] Budgetary accounting
## How is the depreciated cost commonly calculated?
- [ ] By dividing the initial cost by the number of years of the asset's useful life
- [x] By subtracting accumulated depreciation from the asset's acquisition cost
- [ ] By adding periodic maintenance costs to the asset’s initial cost
- [ ] By obtaining an appraisal of the asset’s current market value
## Which accounting method directly affects the calculation of depreciated cost?
- [ ] LIFO method
- [ ] FIFO method
- [x] Straight-line depreciation
- [ ] Fixed asset revaluation
## Depreciated cost helps businesses primarily with which of the following?
- [ ] Maximizing profits in their financial statements
- [x] Preparing more realistic financial statements that reflect asset values over time
- [ ] Determining the selling price of its products
- [ ] Increasing the useful life of assets
## In which financial statement is depreciated cost commonly reported?
- [ ] Income statement
- [ ] Cash flow statement
- [x] Balance sheet
- [ ] Shareholder’s equity statement
## Accumulated depreciation affects which component of the depreciated cost?
- [ ] The initial purchase price
- [ ] The resale value
- [x] The total reduction in the asset’s value
- [ ] The calculated useful life of the asset
## Which type of asset most frequently involves using depreciated cost?
- [ ] Inventory
- [ ] Marketable securities
- [ ] Accounts receivable
- [x] Fixed assets (such as machinery or buildings)
## Depreciated cost must be reported per which governing body’s guidelines in the U.S.?
- [x] Generally Accepted Accounting Principles (GAAP)
- [ ] International Monetary Fund (IMF)
- [ ] Organisation for Economic Co-operation and Development (OECD)
- [ ] Financial Conduct Authority (FCA)
