Establishing the Correct Cost Basis When Calculating Depreciation

Correctly calculating depreciation on an asset requires the determination of an accurate cost basis.  Often, companies may only use the purchasing price of the asset as the basis for calculating their depreciation costs.  However, doing so fails to account for additional costs that should be depreciated along with the actual cost of the asset.  Some additional costs that should be included are installation fees, shipping and handling fees, and applicable taxes.  Also, for real property assets, additional costs can include title insurance, recording fees, survey charges, and settlement and commission fees.  (Note:  there are specific rules governing what asset types can be allotted additional costs including assets acquired by gift/trust, purchase/contract, inheritance, etc.)

Thus, the simple definition for establishing a cost basis is:
Cost Basis = Purchase Price of Asset + Additional Costs Associated with the Asset

To clearly illustrate the importance of properly determining a cost basis, let’s look at the following example:  Consider a computer server with a sales price of $5,000.  However, let’s now include additional costs.  Suppose there are taxes of $350, a shipping and handling fee of $75, and installation charge of $200.  Once these are added to the purchasing cost of $5,000, the actual cost basis of the asset becomes $5,625.  Thus, there now becomes an additional $625 that can be depreciated over the life of the asset.  Below is a comparison of the depreciation allocation with a cost basis of $5,000 vs. $5,625.  For this example, we will assume a salvage value of $0 and a useful life of 5 years and the Half Year Convention.

Comparison of Depreciation Allowances Using Different Costs Bases

As can be seen by the example above, it is important that you make sure to determine the correct cost basis before starting any calculation.  Otherwise, it could cost your company with incorrect deduction amounts. If you have any questions or need help with a specific example, leave a note in the comments and we will help ensure you establish the proper cost basis for your fixed assets.

Questions? Comments? Let us know in the comments section below.

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2 thoughts on “Establishing the Correct Cost Basis When Calculating Depreciation

  1. We have bought a machine in 2008 January. We failed to compute depreciation for the last 3 years (by mistake). Useful life of the asset is 20 yrs. Can we calculate depreciation by reducing the useful life to 17 years from jan 2011 and spreading the effect of depreciation for the balance 17 years or do we have to take the full impact of the 3 years depreciation in 2011. Kindly clarify. Thanks.

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