Depreciable cost is the original or book value of an asset less its salvage value. The difference between these two figures is expensed over the entire useful life of the asset. Companies use depreciation to avoid expensing the entire cost of an asset at one time. As the company expects to use the asset over a long period of time, a better representation of use is calculating the depreciable cost and slowly expensing this amount each month.
Fixed assets usually include items such as buildings, vehicles, equipment; machines and computers are other examples. Most companies purchase these items infrequently as they expect each one to last a significant amount of time. The historical dollar amount paid is the figure that companies will record for fixed assets in their general ledgers. This dollar amount is the starting point for determining depreciable cost. The other two figures are the useful life and salvage value.
The useful life of an asset is the number of years the company expects to use the asset. National accounting standards or government tax authorities may provide standard useful life estimates for different groups of assets. This provides a baseline for all companies to use when calculating depreciable cost. Having standard useful life figures also allows investors to have a certain expectation regarding the useful life of assets among different firms. Tax agencies use standard life spans for ease of reporting annual corporate taxes.
The salvage value is the amount a company can earn when selling a completely used asset. The basic formula for this figure is the market value of the aged asset. For example, a delivery truck with a seven-year useful life may be sold for $5,000 US Dollars (USD) at the end of its useful life. This figure represents the historical selling price of delivery trucks at a certain age and with certain miles. The company subtracts this amount from the book value to determine the original depreciable cost of the truck.
Some assets may not have a salvage value. Companies purchasing specific assets for their production processes may be unable to sell them at the end of their lives. Other times, the company will use the asset to the point where no value remains. The depreciable cost of the asset then is its full original cost or book value. This allows the firm to have a higher annual depreciation, which offsets the lack of a salvage value.