Economics for Engineers

A Report submitted to Dr. B. C. Roy Engineering College, Durgapur for the partial fulfillment of the course
Economics for Engineers-CA2

By Arpita Som

Roll No.- 12001623136;

Semester:- 6th

Subject- Economics for Engineers;

Subject Code – HM HU 601

DEPARTMENT OF ELECTRICAL ENGINEERING

DR. B. C. ROY ENGINEERING COLLEGE, DURGAPUR

MARCH 2025

©Arpit Som. All rights reserved.

Sl. No. Content Page No.

01 Introduction 3

02 Depreciation 4
Overview

03 Why Depreciation Is
5
Important?

04 6
Carrying Value vs.
Market Value

05 7-8
Types of Depreciation
with Calculation Examples

06
Conclusion 9

07
References 10
 Depreciation: Definition and Types, With
Calculation Examples

Introduction:

Definition:
Depreciation is a standard accounting method that lets businesses divide the upfront
cost of physical assets—from delivery trucks to data centers—across the years they
expect to use them.

When a business buys equipment, reporting the full value as an expense right away could
make even profitable companies appear as if they're losing money. Thus, companies often use
depreciation—an accounting method that spreads these big-ticket expenses over time.
Depreciation isn't an accounting trick. It reflects the reality that assets lose value over
time through use and obsolescence. Take Microsoft Corporation's (MSFT) reported plan to spend
$80 billion on AI-enabled data centers in the mid-to-late 2020s[1]. Rather than showing an
enormous hit to net income—on its own, these expenses would have almost zeroed out MSFT's
net income of $88.1 billion in 2024—depreciation allows the company to divide that cost across
the equipment's expected life span[2].
Below, we explain what you need to know about this important practice.

Key Takeaways
• Companies use depreciation to spread the cost of expensive assets like AI infrastructure
or manufacturing equipment across multiple years rather than taking the accounting hit
when the purchase is made.
• This helps match the cost of assets to the revenue they generate over time, providing a
better picture of a company's financial performance.
• Companies can choose from several depreciation methods, including straight-line and
accelerated options, depending on how they want to divide costs over an asset's useful
life.
• While depreciation reduces reported profits on paper, it's a non-cash expense and
doesn't affect a company's actual cash flow.

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Depreciation Overview :
When companies make major investments in physical assets, how should they record these
massive expenses? Rather than taking the full hit upfront, depreciation lets businesses spread
these costs across the years they'll use the equipment.
Here's a breakdown of the main concepts involved:
• Tangible asset: Depreciation applies to physical assets expected to
last for more than one year (often called fixed assets or capital
assets). Land is not depreciated since it's considered to have an
unlimited useful life.
• Useful life: This is the estimated period that the equipment will be
productive for the business, which isn't necessarily how long the
equipment will last. Instead, it's the period it's expected to be
used by that specific business. Useful life is often dictated by
accounting standards or tax regulations[3].
• Cost: This includes the purchase price and any expenses to get the
asset ready for use (e.g., shipping, installation, and setup)

Depreciation moves these costs from the company's balance sheet (where assets are
recorded) to its income statement (where expenses are tracked).

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 Why Depreciation Is Important?

Here are the core reasons depreciation is a crucial part of modern accounting methods:
• The matching principle: This longstanding principle in accounting means that expenses
should be recognized in the same period as the revenues they help generate[4].
• A better depiction of a company's financial position: Likewise, it provides a more
accurate representation of a company's financial position and performance.
• Tax benefits: Depreciation is a tax-deductible expense. This reduces taxable income and,
therefore, the amount of tax a company owes.
• Managing company assets: Depreciation helps businesses track the value of their assets
and plan for future replacements.
Depreciation in Accounting
While a company might spend cash upfront to buy equipment, the depreciation expense
appears spread out across multiple financial statements, reflecting how that equipment's value
decreases through use.
Companies normally must follow generally accepted accounting principles issued by
the Financial Accounting Standards Board when recording depreciation. These standards
require matching expenses with related revenue. So, if a machine helps make products for five
years, its cost should be spread across those five years rather than hitting the books all at once.
Setting Depreciation Thresholds
Most businesses set minimum amounts to determine whether they'll depreciate an asset
or expense it right away[5]. A small business might set this threshold at $500, while larger
corporations often use higher limits like $5,000 or $10,000. It's simply not worth the time and
accounting costs to depreciate everything a company buys for these purposes.
How Assets Are Valued
These aspects of depreciation are used to track an asset's value over time:
• Accumulated depreciation: This represents the total amount depreciated since the
purchase was made. So, if a $50,000 machine depreciates $10,000 annually, its
accumulated depreciation would be $30,000 after three years.
• Carrying Value (or book value): This represents what's left after subtracting
accumulated depreciation from the original cost. In our example, the machine's carrying
value would be $20,000 after three years.
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 • Depreciable base (or depreciable cost): It's not the original cost (purchase price plus
delivery, etc.) used for calculating depreciation, but the depreciation base. It's calculated
as follows: Cost - Salvage Value = Depreciable Base.
• Depreciation rate: This is the annual percentage at which an asset is depreciated over its
useful life. For example, if a company expects an asset to depreciate $1,000,000 over its
lifetime and the annual depreciation is $200,000, the depreciation rate is 20%.
• Salvage value (or residual value): This is what the company expects to receive for the
asset if it's sold, scrapped, or traded in. Generally, the longer the useful life, the lower the
residual value; sometimes, the salvage value is zero[5].
Not all assets qualify for depreciation. For instance, while Microsoft can depreciate its
AI servers and the buildings that hold them, it can't depreciate the land underneath them.

Carrying Value vs. Market Value:

While carrying value tracks depreciation on the books, it often differs significantly from
what an asset would actually sell for—its market value. Consider Microsoft's data centers:
Their carrying value might show steady depreciation over time, but their market value could be
higher because of the surging demand for AI infrastructure, or lower if newer, more efficient
technology makes them obsolete faster than expected. Thus, the gap between the carrying value
and the market value can be substantial.
Depreciation and Taxes
Companies also use depreciation to cut their tax bills with the Internal Revenue Service.
For example, when Microsoft invests $80 billion in AI infrastructure, it will deduct portions of
those purchases each year, lowering its corporate tax bill.
The tax code generally requires companies to spread these deductions across multiple
years, matching how they expect to use the asset. (Section 179 of the tax code offers businesses
some flexibility—in some cases, they can deduct the entire cost of qualifying equipment in the
first year.)
These are the criteria the IRS has set for what can be depreciated:
• Be owned by the business (not leased)
• Be used for business or income-producing activities
• Have a useful life that can be calculated
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 • Be expected to last more than a year
• Not fall under excluded categories, such as intangible property (these are
generally amortized) or equipment used for building the capital improvements3
The IRS publishes schedules giving the number of years over which different types of
assets can be depreciated for tax purposes[6].

Types of Depreciation with Calculation Examples:

Companies can choose from several methods to depreciate their assets. To demonstrate,
we'll use the example of a company purchasing a $50,000 computer server with an expected
useful life of five years and a $5,000 salvage value.
Straight-Line Method
The straight-line method is the simplest and most common. It spreads the cost evenly
across an asset's life. Using the above figures, we get the following:
• Total depreciation: $45,000 ($50,000 - $5,000 salvage value)
• Annual depreciation: $9,000 ($45,000 ÷ 5 years)
• Depreciation rate: 20% (1 ÷ 5 years = 0.20 or 20% per year)

Declining Balance
The declining balance method accelerates depreciation by using the straight-line
percentage (20% in our example) and applying it to the remaining balance:
• Year 1: $10,000 ($50,000 × 20%)
• Year 2: $8,000 ($40,000 × 20%)
• Year 3: $6,400 ($32,000 × 20%)
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 Double-Declining Balance
This method doubles the declining balance rate (20%), front-loading even more
depreciation:
• Year 1: $20,000 ($50,000 × 40%)
• Year 2: $12,000 ($30,000 × 40%)
• Year 3: $7,200 ($18,000 × 40%)
Sum-of-the-Years' Digits (SYD)
The SYD method also accelerates depreciation but is calculated differently. For a five-
year asset, add years 1+2+3+4+5 = 15. Then use these fractions against the depreciable amount
($45,000):
• Year 1: $15,000 ($45,000 × 5/15), using the highest number first
• Year 2: $12,000 ($45,000 × 4/15), second largest number
• Year 3: $9,000 ($45,000 × 3/15), and so on
Units of Production
This method accounts for usage rather than time. If the server is expected to process 1
million computations in its lifetime, you might get something like the following:
• Depreciation per computation = $45,000 ÷ 1,000,000 = $0.045
• If it processes 300,000 computations in Year 1, depreciation would be $13,500 (300,000
× $0.045)[7].

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Conclusion:

The Bottom Line

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References:
[1] https://www.cfodive.com/news/ai-drive-record-growth-2025-big-tech-capex-
ubs/737240/
[2] https://www.microsoft.com/investor/reports/ar24/index.html
[3] https://www.irs.gov/taxtopics/tc704
[4] https://www.jstor.org/stable/44988603
[5] https://www.mheducation.com/highered/product/Essentials-of-Corporate-
Finance-Ross.html?cid=ppc|HE|PDP_Students_Dynamic|Google|&gad_source=1
[6] https://www.irs.gov/publications/p946#en_US_2020_publink1000107576
[7] https://www.investopedia.com/terms/d/depreciation.asp

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