According to BusinessDictionary, depreciation can be defined as "the gradual conversion of the cost of a tangible capital asset or fixed asset into an operational expense (called depreciation expense) over the asset’s estimated useful life" (WebFinance, Inc., 2012).
Depreciation is the expiration of the useful life of an asset. As you use the asset, it becomes an expense; when you use a fixed asset (as discussed on the previous page), that amount becomes a depreciation expense.
Remember that you cannot change the asset account; it remains on the books at its cost. Therefore, you would create a contra account titled "Accumulated Depreciation," recording the amount of the asset that has been used in this and the depreciation expense account. More on this later.
Market value is what two people are willing to accept in a trade without any constraints or pressure. For example, if I am selling my car and you are buying my car, the market value is what I am willing to sell it for and what you are willing to pay for it. If I have the car priced at $15,000 and no one is willing to pay that much, then the market value is not $15,000. If you want to purchase a car for $8,000 and no one will sell the car for that price, then the market value of that car is not $8,000.
Book value is the cost of the asset that has not yet been recovered by its use; it is what the owner still has invested in the asset.
Book value is also depicted on the balance sheet to provide the stakeholders with an accurate statement of the remaining productive use of the assets. The market value is seldom equal to the actual depreciation for an asset; therefore, market value normally does not equal book value.
Imagine that a 2010 vehicle was purchased for $24,000 with an expected life of four years. At the end of 2013, three of those years have expired; therefore, the book value would indicate that one-fourth of the cost had yet to be recovered, and the owner still had an investment of $6,000 in the vehicle. Book value has nothing to do with market value, and it is quite possible that the car might have a market value significantly higher than $6,000 if a seller and buyer agree on a sales price.
In order to determine the usage of a fixed asset during an accounting period, the following items must be determined:
There are many methods used to determine the amount of depreciation that will be attributed to each accounting period, but the most common are