Depreciate Cost and Depreciation

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Last Updated on August 7, 2018 by Naeem Javid Muhammad Hassani

Depreciate Cost and Depreciation

Depreciate cost:

  • It is the wear and teas cost of something or technically, the cost of operation which deals with the loss of initial value of fixed investment/ cost through the use of equipment or the durable character like machinery, building, tools, etc is known as depreciation cost.

DEPRECIATION:

The capital assets on account of wear and tear lose their utility with the passage of time resulting in the decrease of their market value. This drop or reduction in market value is known as Depreciation. Depreciation may also be due to obsolescence ie replacement of old technology by the new one.

Depreciation is that class of operating costs which deals with the losses of initial value of the fixed investment. It is always charged on capital assets as cost against the output of the year. Capital assets are machinery, land, buildings, expandable materials, etc.



Method of Accounting Depreciation:

  1. Straight line method
  2. Declining balance method
  3. Unit production method

For the calculation of depreciation through any method we need the following information:

  1. Initial Cost of the element/ thing or asset
  2. Estimated useful life of that thing eg somebody has a tractor and company says that it can work for 5 years or 20,000 hours. This is the estimated useful life. This method distributes depreciation evenly throughout the useful life of the asset.
  3. The residual value of that thing. For example, after so many years the tractor has a value of 5000 Rs which is its residual value.
  4. Wreckage/ wrecking/ salvage/ scrap value. For example, the tractor is of no use anymore we sell it to the scraper only as a scrap; it is its wrecking value.

Straight line method:

  • By this method, we assume that depreciation is actually returned to the investor eg a banker who may give us a loan for anything of business, when the depreciation starts, the capital or the Income-Bearing-Investment (IBI is the amount of money which was invested to get the income) starts decreasing.
  • In other words, the PBI (Profit-Bearing-Investment) goes on decreasing, which should be calculated.
  • For example, We have a machine to install whose;

Initial cost = Rs 10,000

Useful life = 10 years

Residual value = Rs 2000/-

The Annual Depreciation (AD) = (Initial cost – Salvage value) / Life in years

AD = 10,000 – 2000 / 10

AD = Rs 800/ per year

Now Depreciation rate (DR) = (AD / Initial cost) × 1000

= 800 / 10,000 × 100

DR = 8%

This method is useful for the assets having some utility every year. Same productive capacity each year.

Merits: It distributes the depreciation charges evenly throughout the life of assets.

In forestry, commonly straight-line method is used.

Declining balance method:

Depreciation in this method is computed on book value rather than the initial cost of the asset.

Book value = Initial cost – Accumulated depreciation

BV = 10,000 – 2000 = 8000

Here the rate of depreciation used in the rate of deprecation of straight-line method × 2

For example:

Initial cost = 10,000

Life = 5 years

Scrap value = 0

Now depreciation rate by straight-line method is 20%

Year Initial cost Book value Depreciation rate Depreciation value Accumulated Depreciation
1 10,000 10.000 40 % 4000 4000
2  — 6000 40 % 2400 6400
3  — 3600 40 % 1440 7840
4  — 2160 40 % 864 8704
5  — 1296 40 % 518-40 9222-4
6  — 777-60 40 % 311-04 9533-44
7  — 466-56 40 % 186-62 9720-06
  • We don’t take into account the scrap or salvage value in this method.

Merits:

  • This method is appropriate for the assets which are earning more in the initial years and less in the later life eg machines, automobiles, etc.

Unit production method:

  • In this method, the depreciation is calculated considering ‘per unit of production’ instead of time as in the case of the previous method.
  • Eg a tractor has initial value 20000 Rs. The lifetime of the tractor is 2000 hours. And the residual value (after 2000 hours) is 0.
  • Depreciation rate will simply be = initial cost / life time ie 20000 / 2000 = 10 Rs (which is per hour not per year).
  • Suppose the tractor plows one acre in one hour, so it will plow 2000 acres in 2000 hours or in other words the production per hour is one acre.
  • Now it is our will, whether we use it up in the first year or in a number of years. See the schedule
Years Production  Dep charges
1st year 1300 acres 1300 * 10 = 13000
2nd year 500 500 * 10 = 5000
3rd year 200 200 * 10 = 2000
2000 acres 20,000

Money Yield Tables:

  • Money yield tables are the tables constructed from money volume tables in which the yields are expressed in the form of money instead of volume.
  • Money yield depends upon the volume obtained at any age and price per cubic feet at which it can be sold, so that from any given volume yield tables, various money yield tables, may be constructed by the introduction of different prices. Also, each quality class of a volume yield tables will give a different set of money yield tables.
  • For the construction of MYT for a give spp or a given site, it is necessary to know the price per cft that may be expected for each size of the tree of the spp under consideration
  • For this purpose prices as generally adopted but if it is thought that the market will change other prices may be inserted or it may be assumed that prices will rise at a certain rate eg 1%.

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Naeem Javid Muhammad Hassani

NJMH is working as Deputy Conservator of Forests in Balochistan Forest & Wildlife Department (BFWD). He is the CEO of Tech Urdu (techurdu.net) Forestrypedia (forestrypedia.com), Majestic Pakistan (majesticpakistan.pk), All Pak Notifications (allpaknotifications.com), Essayspedia, etc & their YouTube Channels). He is an Environmentalist, Blogger, YouTuber, Developer & Vlogger.

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