Depreciation is one of the most commonly used—and misapplied—areas in financial accounting. Although it may seem like a mechanical process, depreciation errors can seriously impact financial statements, tax reporting, and decision-making.
Under U.S. Generally Accepted Accounting Principles (GAAP), the systematic recognition of depreciation must reflect the pattern in which the asset’s economic benefits are consumed. However, many businesses fail to apply depreciation methods correctly, ignore useful life reviews, or don’t document impairment when necessary.
- What Does GAAP Say About Depreciation?
According to FASB ASC 360 (Property, Plant, and Equipment), depreciation must:
- Be estimated based on the asset’s useful economic life.
- Reflect the expected pattern of use.
- Be reevaluated if usage conditions, productivity, or the economic environment change.
The most common mistake? Treating depreciation as a fixed automatic Excel figure for 5 or 10 years—even when the asset is clearly becoming obsolete or no longer producing benefits.
- Frequent Mistakes to Avoid
- Using the straight-line method incorrectly when the asset generates uneven benefits.
- Failing to review the useful life periodically, as required by ASC 250.
- Not recognizing impairment losses when the asset’s recoverable value falls below book value.
- Changing depreciation methods without accounting justification or proper financial statement disclosure.
- Omitting depreciation during slow operational years, violating the consistency principle.
How Do You Correct a Depreciation Error?
According to ASC 250-10, if a depreciation error is material, it must be corrected through retrospective restatement of the financial statements.
However, if the correction is made for tax purposes—and the asset was depreciated incorrectly under the IRS MACRS system—you may request an accounting method change using:
IRS Form 3115 – Application for Change in Accounting Method
IRS Form 3115 – Instructions
- What Are the Consequences of Poor Depreciation?
- Distorted net income
- Understatement or overstatement of asset values
- Issues with banks or investors due to misleadingly strong financials
- IRS adjustments and penalties for improper deductions
- Noncompliance with disclosure and consistency principles
Key Recommendations
- Review your accounting policies annually and document any changes.
- Evaluate whether usage patterns have changed (e.g., outdated tech, physical damage, reduced productivity).
- Consult a professional to apply impairment tests or change depreciation methods.
- Use professional judgment alongside your auditor; don’t rely solely on static formulas.
- Ensure all changes are properly disclosed in the notes to financial statements.
Conclusion
Depreciation under GAAP is more than a formula—it’s an estimate based on professional judgment, economic evidence, and solid accounting principles. Overlooking these details can damage financial credibility and regulatory compliance.
With training in financial and tax standards, I can help you review your assets, correct past errors, and build a sound depreciation policy that supports both audits and strategic decisions.
José Jiménez, MACC
Accounting Professional | Specialized in Financial Accounting under GAAP.