Definition of 'Economic Depreciation'
There are two main types of economic depreciation:
* **Physical depreciation** is the decrease in the value of an asset due to wear and tear. This can be caused by a number of factors, such as the use of the asset, the environment in which it is used, and the maintenance that is performed on it.
* **Obsolescence depreciation** is the decrease in the value of an asset due to the introduction of new and improved technology. This can make an asset obsolete and reduce its value.
Economic depreciation is important because it allows companies to account for the decrease in the value of their assets over time. This information can be used to make decisions about when to replace assets and how to manage their costs.
There are a number of methods that can be used to calculate economic depreciation. The most common method is the straight-line method, which allocates an equal amount of depreciation expense to each year of an asset's useful life. Other methods include the declining-balance method and the sum-of-the-years'-digits method.
The choice of depreciation method can have a significant impact on a company's financial statements. The straight-line method results in the lowest depreciation expense each year, while the declining-balance method results in the highest depreciation expense each year. The sum-of-the-years'-digits method falls somewhere in between.
Companies must choose a depreciation method that is consistent with their financial reporting policies. They must also disclose the method they use in their financial statements.
Economic depreciation is a complex topic. If you have any questions, please consult with a qualified accountant.
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