What is Depreciation Basis?

Depreciation basis is the amount of a fixed asset's cost that can be depreciated over time. This amount is the acquisition cost of an asset, minus its estimated salvage value at the end of its useful life. Acquisition cost is the purchase price of an asset, plus the cost incurred to put the asset into service. Thus, the acquisition cost can include sales taxes, customs duties, freight charges, on-site modifications (such as wiring or a concrete pad for the asset), installation fees, and testing costs.

Many organizations plan to use an asset and then scrap it. If so, they assume that there will be no salvage value, in which case the depreciation basis of an asset is the same as its cost. The use of no salvage value in the derivation of depreciation basis is the standard approach, since it reduces the complexity of the depreciation calculation.

Characteristics of Depreciation Basis

The key characteristics of depreciation basis are as follows:

Acquisition cost. Includes the original price paid to acquire the asset, plus related costs. This cost is adjusted for incentives, such as reductions for trade discounts or grants.
Excludes non-capital costs. Excludes expenses not directly related to asset acquisition or preparation, such as maintenance costs, operating costs, and interest on loans.
Reduction for salvage value. The estimated residual value (salvage value) of the asset at the end of its useful life is subtracted from the acquisition cost to determine the depreciable amount.
Useful life dependency. The depreciation basis works in conjunction with the asset's useful life, which determines the time period over which the basis will be allocated.
Includes improvement costs. Any subsequent improvements or upgrades that extend the useful life or increase the value of the asset are added to the depreciation basis.
Excludes repairs. Ordinary repairs are excluded, as they are treated as expenses, not additions to the asset’s basis.
Asset-specific. Depreciation basis is specific to each asset, even if multiple similar assets are purchased together.
Affected by asset disposals. If part of an asset is disposed of or no longer usable, the depreciation basis is adjusted accordingly.
Depreciation method sensitivity. The depreciation basis remains constant, but the choice of depreciation method (e.g., straight-line, declining balance) determines how the basis is allocated over time.
Tax considerations. Depreciation basis calculations must comply with local tax laws and accounting standards, which may define what costs can or cannot be included.

Example of Depreciation Basis

A business buys a machine for $90,000, and pays an additional $1,000 in customs duties, $3,000 in shipping charges, $4,000 for the installation of a concrete pad on which to place the machine, and $2,000 for special electrical connections between the machine and the local power grid. The result is a total machine cost of $100,000. In addition, the accountant estimates that the machine will have a salvage value of $10,000 at the end of its useful life. Therefore, the depreciation basis of the machine is $90,000, which is calculated as follows:

$100,000 Purchase price - $10,000 Salvage value = $90,000 Depreciation basis

The company then uses a depreciation method, such as the straight-line method, to gradually charge the $90,000 depreciation basis to expense over the useful life of the machine.