Depreciation
Depreciation
Depreciation is that class of operating costs which deals with the losses of initial value of fixed investments through dynamic use or obsolescence of capital assets. It is always changed on capital assets as costs against the output of the year. Capital assets are machinery, land, buildings, expandable materials etc.
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The characters of capital assets are
i) Tangible
ii) Long-lived (several years)
iii) Used in the operation of business
iv) Held not for sale but for the production of other goods and services and operation of business.
On account of physical actions these capital assets losses their value due to wear and tear forces and utility due to obsolescence/due to the passage of time. This drop in market value of capital assets is called depreciation. Depreciation may also be due to obsolescence i.e. replacing old ones with new ones.
There are many methods to account for the depreciation. Three of them are:-
1) Straight line method
2) Unit production method
3) Declining balance method
The information required to determine the Dep. Value of fixed capital by any of the one method is
a. An initial cost of element/asset
b. Estimated useful life of the element/asset
c. Residual value or Wreckage/scrap value.
Initial cost = price cost + transportation cost + installation changes.
Estimated useful life = It is generally given by the manufacturer if not, then a guesswork is made to arrive at its lifespan useful for production.
Residual value = Amount expelled to realize from fixed investments at the end of operation provided there is opportunity for continued use in place.
Wrecking/salvage/scrap value = If the value is only for removal and use elsewhere on sale as a scrap, it is known as wrecking value.
1. Straight line method
Suppose we have installed a machine for the production of sawn timber which has initial cost = 10,000/- life (useful)= 10 yrs., and salvage value = 2,000/-
Then annual depreciation (A..D)=Initial cost – residual value
Useful life
= 10,000-2,000 = 800/-
10
Merit:-It distributes the dep. Charges evenly throughout the life of the asset.
Dep. Rate =
If residual value is nominal then it may be ignored. We can simply work out the Dep. Cost on rate only depending upon useful life of the assets i.e.,
10 years. —- 10%, 5 years -20%.
Book value: Initial cost – accumulated Dep.
2. Unit production method:- Dep. is worked out by taking into consideration per unit production instead of per unit of time e.g. a machine having cost Rs.10,000/- life 1,000 hours/days, then we can work out depreciation value/hour/day directly assuming the residual value equal to zero. Therefore,
Dep. Rate = 10,000/- = 10/hour/day.
1,000
Suppose the machine remained under working
Ist year — 150/- hours/days Dep.changes
2nd year ___ 120 hours/days 150×10 = 1500 unit
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“ “ “
“ “ ____________“
Total Charge
Depreciation depends upon the usage of the asset during the period.
3. Declining balance method. In computing Dep. By this method, we have to use the book value and depreciation rate worked out with the help of straight-line method and not the initial cost of the assets. The depreciation rate is twice that calculated depreciation at any given rate.
Suppose book value = 10,000/- Life 5 years; Depreciation rate = 20% by straight-line method; by declining balance method 20x 2 = 40%
|
Year
|
Initial cost
|
Book value
|
Rate
|
Dep.value
|
Accumulated Depreciation
|
|
1
|
10,000/-
|
10,000/-
|
40 %
|
4,000/-
|
4,000/-
|
|
2
|
10,000/-
|
6,000/-
|
40%
|
2,400/-
|
6,240/-
|
|
3
|
10,000/-
|
3,000/-
|
40%
|
1,440/-
|
7,840/-
|
|
4
|
10,000/-
|
2,000/-
|
40%
|
864/-
|
8,704/-
|
|
5
|
10,000/-
|
1,000/-
|
40%
|
518/-
|
9,222/-
|
|
6
|
10,000/-
|
778/-
|
40%
|
300/-
|
9,522/-
|
It will go on decreasing but will never come to zero.
This method is suitable for those assets which are going to lose the earning capacity in the early stages of their life or earning more in the initial years and less in the later part of their useful life e.g, transport, machinery etc.
In Forestry, we use the straight-line method for calculating the depreciation value of assets.
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For correction and improvements please use the comments section below.
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Naeem Javid Muhammad Hassani is working as Conservator of Forests in Balochistan Forest & Wildlife Department (BFWD). He is the CEO of Tech Urdu (techurdu.net) Forestrypedia (forestrypedia.com), All Pak Notifications (allpaknotifications.com), Essayspedia, etc & their YouTube Channels). He is an Environmentalist, Blogger, YouTuber, Developer & Vlogger.