Texas All Lines Adjuster Practice Test

How is annual depreciation calculated for an item?

1. Replacement cost divided by expected lifespan

2. Original cost divided by current market value

3. Replacement cost divided by market value

4. Current value divided by expected lifespan

The correct answer is: Replacement cost divided by expected lifespan

Annual depreciation is determined using a method that assesses how the value of an item decreases over time based on its expected lifespan. The correct method involves dividing the replacement cost of the item by its expected lifespan in years. This approach reflects the principle that as an asset is used over time, its value diminishes, and the replacement cost represents the current cost to replace the item with a similar, new item. By spreading the replacement cost evenly across the expected years of service, you arrive at a clear picture of the annual depreciation expense. The other options do not align with standard depreciation calculation methods. For instance, dividing the original cost by the current market value does not provide a clear measure of how value diminishes over time, as it would yield a figure based on market fluctuations rather than the loss of value through use. Similarly, comparing replacement cost to market value or current value lacks the necessary perspective on lifespan, which is critical for accurately assessing annual depreciation.