Expenses arise from the cost of goods or services that are consumed in the process of generating revenue. When a long-term tangible asset is acquired, it actually represents a bundle of future asset services. The total cost of these services equals the acquisition cost of the asset minus the asset's expected (estimated) market value at the end of its useful life. As a productive asset is used, services (benefits) are consumed; therefore, a portion of the original asset cost should be charged to expense in order to comply with the matching principle. The process of allocating (expensing) the cost of long-term tangible assets over the accounting periods during which the asset is used is called depreciation. The process of allocating the costs of natural resources to inventory (and later to cost of goods sold) is called depletion. Depreciation and depletion are discussed in this chapter.
1. Explain the concept of depreciation. Depreciation is the accounting process of allocating the cost of long-lived tangible assets to expense in a systematic and rational manner to those periods expected to benefit from the use of the asset.
2. Identify the factors involved in the depreciation process. Three factors involved in the depreciation process are (1) determining the depreciation base for the asset, (2) estimating the service life, and (3) selecting a method of cost apportionment (depreciation).