US GAAP Depreciation (CPA Exam Study Guide)
U.S. GAAP depreciation spreads the cost of a long-lived asset over the periods it helps a business earn revenue. For the CPA exam, know when depreciation starts, how to calculate common methods, how to handle estimate changes, and what happens at disposal. Keep book depreciation separate from tax depreciation, and check that carrying value never falls below residual value.
Depreciation questions test more than arithmetic. They ask whether an asset is ready for use, which costs belong in its basis, and whether a later change is an estimate or an impairment. In exam reviews, I find that a simple order of operations helps: identify the rule, choose the method, calculate, then check the result.
The guidance comes mainly from FASB Accounting Standards Codification (ASC) 360, which covers property, plant, and equipment. ASC 250 addresses changes in accounting estimates. This guide follows those rules and focuses on the skills a FAR candidate needs.
Scope: What U.S. GAAP depreciation covers
Depreciation is the systematic allocation of a tangible asset’s depreciable amount over its estimated useful life. It is an expense, not a measure of cash spent this period or an estimate of the asset’s market value. For exam problems, separate cost, residual value, useful life, and the date the asset is ready for use.
A company generally records an asset at its historical cost, including costs needed to acquire it and prepare it for its intended use. The depreciable amount is usually cost minus estimated residual value, also called salvage value. Land is generally not depreciated because it is treated as having an indefinite life; buildings and land improvements are depreciated over their useful lives.
When does depreciation begin?
Depreciation begins when an asset is placed in service: it is in the location and condition needed to operate as management intends. Buying an asset or paying for it does not, by itself, start depreciation. The rule is important when an asset is delivered in one period but needs setup or testing before it can be used.
For example, if a machine arrives in December but is not ready to run until February, it is generally not depreciated in December or January. The company begins depreciation when the machine is available for its intended use. ASC 360-10-35-4 addresses this starting point.
Depreciation methods and calculations
A depreciation method sets how a company allocates an asset’s depreciable amount across periods. U.S. GAAP calls for a systematic and rational method that fits how the asset’s economic benefits are used. The exam commonly tests straight-line, units-of-production, and declining-balance calculations.
| Method | Calculation | Best fit in a problem | Key check |
|---|---|---|---|
| Straight-line | (Cost − residual value) ÷ useful life | Benefits are used evenly over time | Same annual expense, absent a partial period or estimate change |
| Units-of-production | (Cost − residual value) ÷ estimated total units × units used this period | Use varies with output or activity | Use current units, not the asset’s age |
| Double-declining balance | (2 ÷ useful life) × beginning carrying amount | Greater use or benefit occurs earlier | Do not depreciate below residual value |
How do the three methods work?
Straight-line produces the same full-year expense over the useful life when estimates stay constant. Units-of-production links expense to measurable use, such as units made or machine hours. Double-declining balance applies twice the straight-line rate to the beginning carrying amount, so expense is usually higher in earlier years.
Use this example: equipment costs $100,000, has an estimated $10,000 residual value, and a five-year useful life. Straight-line depreciation is ($100,000 − $10,000) ÷ 5, or $18,000 per full year.
Under units-of-production, suppose the equipment is expected to make 90,000 units and makes 12,000 this year. The rate is $90,000 ÷ 90,000, or $1 per unit. This year’s depreciation is $12,000.
Under double-declining balance, the rate is 2 ÷ 5, or 40%. First-year depreciation is $100,000 × 40%, or $40,000. The carrying amount then becomes $60,000. In year two, depreciation is $60,000 × 40%, or $24,000. Continue only while the result does not reduce carrying amount below the $10,000 residual value. In the final year, limit expense as needed to reach, but not pass, residual value.
For a partial year, use the company’s applicable, consistently applied policy and the facts in the question. GAAP does not mean that every asset must use the same month-count convention. If a problem gives a placed-in-service date and a convention, follow it; if it supplies a partial-period amount, use that information rather than assuming a tax convention.
Estimate changes, impairment, and disposal
Depreciation estimates and asset values can change after an asset is placed in service. These events do not all use the same accounting. A revised useful life or residual value changes future depreciation; impairment follows a separate test; disposal removes the asset and its accumulated depreciation from the books.
How do you account for a changed useful life or residual value?
A change in useful life or residual value is a change in accounting estimate. Under ASC 250-10-45-17, apply the revision prospectively, meaning in the current and future periods. Do not restate prior depreciation. Start with the asset’s current carrying amount, then use the revised residual value and remaining useful life.
Suppose equipment originally cost $100,000 and has accumulated depreciation of $36,000 after two years. Its carrying amount is $64,000. If the revised residual value is $4,000 and the asset now has four years of remaining useful life, straight-line depreciation going forward is ($64,000 − $4,000) ÷ 4, or $15,000 a year.
This example assumes the revised estimates apply at the start of the period and that straight-line remains appropriate. On an exam, watch for whether the question provides a new method as well as new estimates. Do not recalculate earlier years unless the question identifies an error rather than a change in estimate.
How is impairment different from depreciation?
Depreciation allocates cost over time. Impairment asks whether an asset’s carrying amount may not be recoverable. For a held-and-used long-lived asset, a company tests recoverability when events or changes in circumstances indicate that the carrying amount may not be recoverable.
Under ASC 360, compare the asset’s carrying amount with the sum of its expected undiscounted cash flows. If carrying amount is greater, the asset is not recoverable, and the company measures an impairment loss using fair value. Do not use discounted cash flows for the initial recoverability comparison. Depreciation continues to be a separate allocation process.
What happens when an asset is disposed of?
On disposal, remove the asset’s cost and related accumulated depreciation from the accounts. Compare any proceeds with the asset’s carrying amount at disposal. Proceeds above carrying amount create a gain; proceeds below it create a loss.
For example, equipment with a $30,000 carrying amount is sold for $34,000. The company records a $4,000 gain, removes the asset and accumulated depreciation, and records the cash received. If the asset is scrapped with no proceeds, the remaining carrying amount is generally a loss. Make sure depreciation is recorded through the disposal date when the facts and company policy require it.
Illustrative case: a machine placed in service midyear
Consider a manufacturer that buys a $100,000 machine in December, then completes setup and testing in March. If the machine is ready for intended use on March 1, depreciation starts then, not on the purchase date. With a $10,000 residual value and five-year life, straight-line expense for a full year is $18,000.
If the company uses a monthly partial-year policy and the machine is in service for ten months that year, expense would be $18,000 × 10/12, or $15,000. This is an illustration, not a universal GAAP convention. The exam’s stated facts and policy control.
A practical FAR study plan
A strong study routine joins recognition, calculations, and later accounting into one sequence. Instead of memorizing formulas in isolation, practice identifying what the problem asks before calculating. This keeps a correct formula from being applied to the wrong period, asset amount, or accounting issue.
Work each problem in a fixed order
- Identify the asset’s cost and any residual value.
- Find the placed-in-service date.
- Note the useful life, method, and any partial-period instructions.
- Calculate depreciation for the period.
- Update accumulated depreciation and carrying amount.
- Check that carrying amount is not below residual value.
- Decide whether the question instead concerns an estimate change, impairment, or disposal.
Then practice mixed questions. A task may give a new useful life, ask for current-year expense, and require the ending carrying amount. Another may provide impairment indicators and ask whether to record a loss. Label each step so you can see where an error starts.
A high-risk mistake is using MACRS or another tax depreciation schedule for financial statements. Tax recovery periods and conventions do not set book depreciation under U.S. GAAP. Use tax rules only when the question asks about tax accounting; for book reporting, use the GAAP method and facts provided.
For exam practice, show the formula before inserting numbers. Keep a short schedule with beginning carrying amount, current depreciation, accumulated depreciation, and ending carrying amount. This is especially useful for declining-balance problems, estimate changes, and disposals.
Key takeaways and FAQs
Depreciation questions become easier when you separate the asset’s basis, the start date, the allocation method, and later events. For each problem, apply the specific facts and check the ending carrying amount. The answers below cover common exam questions and reinforce the main U.S. GAAP rules.
1. What is the basic U.S. GAAP depreciation formula?
For straight-line depreciation, subtract estimated residual value from cost, then divide by useful life.
2. When does depreciation start under U.S. GAAP?
It starts when the asset is placed in service and ready for its intended use, not simply when purchased or paid for.
3. Is residual value included in depreciable basis?
No. Depreciable basis is generally cost less estimated residual value.
4. Can carrying amount fall below residual value?
No. Depreciation is limited so the asset’s carrying amount does not fall below its estimated residual value.
5. How do you calculate double-declining-balance depreciation?
Multiply the beginning carrying amount by twice the straight-line rate. Stop or limit expense so carrying amount does not go below residual value.
6. How do you account for a revised useful life?
Treat it as a change in estimate and apply it prospectively, using the current carrying amount and revised remaining life.
7. Does a change in residual value require restating past depreciation?
No. A revised residual value is generally applied to current and future periods, not prior periods.
8. How does impairment differ from depreciation?
Depreciation allocates cost over useful life. Impairment tests whether a held-and-used asset’s carrying amount is recoverable when indicators exist.
9. Which cash flows are used in the ASC 360 recoverability test?
For the initial test, compare carrying amount with expected undiscounted cash flows. If the asset is not recoverable, measure the loss using fair value.
10. Should a company use MACRS for book depreciation?
Not by default. MACRS is a tax depreciation system and does not establish U.S. GAAP book depreciation.
11. How do you calculate a gain or loss on disposal?
Compare proceeds with carrying amount at disposal. Proceeds above carrying amount create a gain; lower proceeds create a loss.
12. What is the best first check on a depreciation exam problem?
Confirm the asset is placed in service and identify the method, cost, residual value, useful life, and period before calculating.
For review, consult FASB ASC 360-10-35 for long-lived asset guidance, ASC 250-10-45-17 for changes in estimates, and the current AICPA CPA Exam Blueprints for FAR exam scope.
(This article was written by one of our staff writers, James Holloway. Visit our Meet the Team page.)
