by Leigh Goessl

Created on: February 16, 2010   Last Updated: March 16, 2010

In business accounting, categories of items that determine the financial health of the company are broken up into assets, liabilities and owner's equity. These are the three primary component's that make up the basic accounting equation.

To understand the various accounting depreciation methods it is important to first get a grasp on understanding what fixed assets are and why they are important to any company.

Assets are a company's resources. There are many different kinds of assets and one of the primary asset categories is fixed assets. Fixed assets are also known by terms such as Property, Plant and Equipment, or any combination of these words.

Essentially fixed assets are those resources which the company will own for a long period of time and are a significant investment of property. Without these large assets, the capacity of a company's operation would be negatively impacted.

For instance, how many customers could be served by a taxi company if only one taxi were owned? Or how much corn could be grown on one acre as opposed to 12 acres? The ability to serve or produce is essential to a business' success and capacity to serve customers.

Due to the importance of this concept, companies must carefully monitor their fixed assets because without them, their ability to produce would be very limited.

As a result of the need to maintain fixed assets, managerial decision makers must constantly monitor the needs and acquire new assets when deemed necessary. Otherwise the company's financial health is bound to be negatively impacted at some point as assets wear down, need replacing or become outdated from a technology standpoint.

Depreciation helps managers monitor their fixed assets over time.

*What is Depreciation?

Depreciation is a way for companies to allocate the cost of a fixed asset over its useful life. According to investorwords.com "A noncash expense that reduces the value of an asset as a result of wear and tear, age". Over the course of time many assets lose their value, or physically wear out.

Another important factor to keep in mind when understanding the concept of depreciation is that depreciation is a cost allocation process, it does not necessarily mean the depreciation placed on a fixed asset will equate to the market value of that asset. Three factors are involved when computing depreciation and these are original cost, useful life and the salvage value, if any.

When applying depreciation to fixed assets, typically three methods are used which

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