Legal Definitions - replacement-cost depreciation method

The replacement-cost depreciation method is a formula used to estimate the wear, use, or obsolescence of an asset over its useful life. This method is helpful in calculating the annual tax deduction for depreciation.

For example, let's say a company purchases a machine for $10,000. The machine has a useful life of 5 years and a salvage value of $2,000. Using the replacement-cost depreciation method, the company would estimate the cost of a substitute machine and use that value to calculate the annual depreciation expense. If the cost of a substitute machine is $8,000, the annual depreciation expense would be $1,200 (($10,000 - $2,000) / 5 years) instead of using a fixed percentage or rate.

This method is useful for assets that have a high replacement cost or are subject to frequent technological changes. By using the replacement cost, the company can more accurately reflect the true value of the asset over its useful life.