Depreciation

Depreciation is the fall in the value of assets — buildings, machinery, equipment of every kind — as they are used over time. A few terms describe how this loss is measured.

The scrap value (also called residual or salvage value) is what a depreciable asset is worth at the very end of its useful life. The total depreciation (or wearing value) is the difference between the asset's original cost and its scrap value. The book value is the difference between the original cost and the depreciation accumulated up to any given date — that is, what the asset stands at in the books on that date.

Methods of computing annual depreciation. Three methods are commonly used: the Straight Line Method, the Sum of the Years' Digit Method, and the Written Down Value (reducing balance) Method.

Linear or Straight Line Method. This is the simplest and most widely used method for fixed assets. Assets such as buildings, machinery, computers, automobiles and electronic items last more than a year but not forever — their value drops year by year through passage of time, wear and tear, becoming outdated, accidents and the like, while repair costs rise. Under this method a fixed percentage of the original cost is written off every year, so the depreciation amount is the same each year. With $D$ the annual depreciation, $C$ the original cost, $S$ the estimated scrap value and $n$ the useful life in years:

Here $C - S$ is the total depreciation spread evenly over the life. A few rules on timing apply: when the rate is given per annum (e.g. 10% p.a.) and the date of acquisition is known, depreciation is charged only for the part of the year the asset is actually held; when the acquisition date is not given, it is charged for the full year; and when the rate is quoted without the words "per annum," it is again charged for the full year. This method is simple, lets an asset be depreciated down to its scrap value, and gives a depreciation amount that is easy to read off because it is uniform every year.

Sum of the Years' Digit Method. Here the fraction of the asset depreciated each year is found by writing the year digits in reverse order over the sum of the digits of the life span, so a greater share of the cost is written off in the earlier years. …