When you hear the term “depreciation reserve”, it can seem like a foreign concept. It’s a term used in accounting that can obfuscate what it actually is and what it does. Luckily, with a little further explanation, understanding the fundamentals of depreciation reserves can be simple.
What Is a Depreciation Reserve?
A depreciation reserve is an account or fund which holds the amount that a company has set aside to cover the expected cost of its depreciating assets. Depreciation is an estimate of the wear and tear that occurs on a company’s assets, such as vehicles, buildings, and equipment, and the depreciation reserve is simply the amount of money that the company has created to pay for those expected costs when they occur.
How Does It Work?
A company determines the anticipated costs associated with its capital equipment by analyzing its track record and its current asset list. Then, it allocates funds to the depreciation reserve so that it has money to cover those expected costs when they become due, rather than paying them out of its operating budget. This is useful because it allows the company to finance the costs of its aging assets without impacting its operational budget.
The Benefits of Utilizing a Depreciation Reserve
The use of a depreciation reserve comes with a host of benefits, such as providing a buffer from volatile asset prices. Additionally, it can create additional tax savings, as depreciation expenses are tax deductible. Finally, it can help ensure that a company’s capital investments are adequately covered for the future.
The Bottom Line
Depreciation reserves are an important tool in helping manage the cost of a company’s aging assets. By setting aside funds to cover those costs, companies can maintain controlled budgets and ensure adequate coverage for the future.