Long-term assets provide benefits to businesses over several years, therefore, it is not appropriate to recognize the total cost of such assets as an expense either in the year of acquisition or in the year of disposal. Recognizing periodic depreciation expense matches the cost of a non-current asset to the benefit earned from its use in the business.
In effect, the cost-less residual value of the asset will transfer to the statement of comprehensive income over the period for which the asset is used. It is important to understand that depreciation is not a decrease in the value of the asset;
Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life.
Depreciable amount is the cost (or revalued amount) of an asset less its residual value.
The residual value of an asset is the estimated amount that an entity would currently obtain from the disposal of the asset.
Useful Life is:
- The period over which an asset is expected to be available for use by an entity; or
- The number of production or similar units expected to be obtained from the asset by an entity.
Accumulated Depreciation
Accumulated Depreciation is the depreciation charged to date (cumulative) on a non-current asset. This is contra asset account (a negative balance of the asset).
Carrying amount net book value (NBV) or written down value (WDV)) is the amount.
Carrying amount = Cost or revalued amount – accumulated depreciation – accumulated impairment
Example
ABC Enterprise bought a machine for Rs. 700,000 in early 2021. Although the machine can be used for seven years ABC Enterprises expects to use it for 5 years only.
ABC Enterprise estimated that the machine can be disposed of for Rs. 620,000 (at current prices) and for Rs. 680,000 (at prices expected at the end of 2025). Further, a 5-year-old similar machine can be disposed of for Rs. 150,000 (at current prices) and for Rs. 330,000 (at prices expected at the end of 2025). Determine the useful life and residual value of the above machine.
Answer
The useful life is 5 years
The residual value is Rs. 150,000 which can be currently obtained if the machine was already in 5 year old condition.
Example
An asset costs Rs. 100,000 and can be used for ten years. The management of the business entity intends to use the asset for six years at which point the expected residual value will be Rs. 40,000 (at current prices).
Required: What is the depreciable amount and useful life of the above asset?
Answer
Depreciable amount = Rs. 100,000 – 40,000 = Rs. 60,000
The useful life is six years as intended by the management of the entity.
Frequently Asked Questions
What is depreciation?
Depreciation is an accounting method that allocates the cost of a tangible asset over its useful life. Asset loses value over time due to wear and tear, obsolescence, and other factors.
What are the different types of depreciation methods?
There are four main types of depreciation methods:
- Straight-line
- Declining-balance
- Sum-of-the-years’-digits
- Units-of-production
Which depreciation method should I use?
The best depreciation method to use depends on some factors, including the type of asset, the expected useful life of the asset, and the business’s accounting and tax needs. It is important to consult with an accountant to determine the best depreciation method for your business.
How do I calculate depreciation?
The formula for calculating:
Depreciation expense = (Cost of Asset – Salvage Value) / Useful Life of Asset
The salvage value is the estimated value of the asset at the end of its useful life. The useful life is the life of the asset in years or months.
Can I depreciate land?
No, land cannot be depreciated. This is because land does not lose value over time.
How do I claim depreciation on my tax return?
To claim depreciation on your tax return, you will need to file a Form. This form requires information about the asset, such as its cost, salvage value, and useful life. You will also need to choose its method.