What is Depreciation? Diffrent method of depreciation.
Meaning of Depreciation.
Depreciation is the loss of value that an asset represents as a result of its use or its period of existence.Its purpose is to manage the resources for the replacement of deteriorating assets and, in this way, preserve their productive capacity. To carry out this process, the time and productivity of the assets are taken into consideration.
The term is also used to refer to the wear of the coin. All assets suffer a normal deterioration over time until they reach their total uselessness. Depreciation is the mechanism that allows such impairment to be recognized and prevents large losses from it. When an asset is used to generate money, a budget must be used to remodel it according to the depreciation it suffers and continue to make a profit on it as well.
Depreciation occurs due to three factors: wear, the passage of time and the passing of fashion or obsolescence of the asset. The term is used in accounting and economics. Depreciation, seen from a financial and economic point of view, is responsible for creating a reserve that allows the asset to be replaced, if it reaches the end of its useful life.
When buying a new asset, a higher amount is paid than that paid for a second-hand asset. This is due to the fact that, as it has not been used previously, a longer useful life is ensured and the necessary depreciation investments will be less. There are depreciation methods that allow calculating the investments that will be required for the maintenance of an asset according to its time of use.
Depreciation Methods
straight line method
It is one of the most used methods. It remains the same for every year of the asset's useful life. Assumes constant depreciation based on time and not on the use of assets. To calculate depreciation, the value of the assets is divided by their useful life. Depending on the type of property, its useful life may vary.
Real estate: useful life of twenty years.
Machinery and equipment: useful life of ten years.
Vehicles and computers: useful life of five years.
Depreciation can be divided monthly or annually. What is known as: the residual value is also calculated; value for which the asset can be sold at the end of its useful life.
Units Produced Method
It is specifically used to calculate the wear and tear of vehicles and machinery, since these assets imply a deterioration directly proportional to their usefulness. The greater the productive capacity of these assets, the greater the income produced, and therefore, their wear and tear. It is also one of the most difficult to use, because it is very complex to calculate the wear and tear of these assets, since certain external factors can influence it.
To calculate depreciation, this method is based on production and how long the asset will be working or, in the case of a vehicle, the distance it will travel. In this case, its acquisition cost is divided by the estimated mileage traveled.
Decreasing methods
These methods are used when depreciation values are higher in the first years of the asset's useful life and decrease until it is useless. This happens when it comes to a type of asset that is more efficient at the beginning of its productivity. This method is divided into two:
Sum of the annual digits method: in this method, the scrap value of what the asset has cost is reduced and multiplied by a fraction, where the numerator is the useful life that the asset still has and the denominator is its useful life.
Double Declining Balance Method
In the first year, the total cost of the asset is multiplied by a percentage that is equal to twice the annual depreciation under the straight-line method. The same operation is repeated during the following years, so the value of the asset is higher in the first years and likewise with the other years, successively.
Balance Reduction Method
It is used to achieve accelerated depreciation. For its use, a salvage value is used, otherwise, the first year 100% of the asset would be depreciated. It is calculated by dividing the salvage value by the value of the asset and this, in turn, is multiplied by its useful life.
How does depreciation work.
Companies depreciate long-term assets for both accounting and tax purposes. Declining asset value affects a company's balance sheet. It is important that we remember that it does not give rise to any cash outflow; it just means the asset isn't worth as much as it used to.
The method of depreciation of the asset, from an accounting point of view, affects the net income. The cost is generally allocated as depreciation expense between the periods in which the asset is expected to be used. Depreciation calculation methods can vary between asset types within the same business.
How depreciation is calculated
There are several methods for calculating depreciation expense, including the straight-line, reduction-of-balances, sum-of-the-digits, and units-of-production method. Depreciation expense generally begins when the asset is placed in service.
Depreciation can stem from three main reasons: wear and tear, the passage of time, and old age.
In short, calculating depreciation is very useful for our company. Well, it will help us anticipate and deduct future expenses through the creation of a reserve fund.
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