Module 1.4

• Depreciation - annual loss in book value due to use, wear, tear, age, and technical obsolescence
• Depreciation

  • Both considered as a
  • business expense that reduces annual profit and
  • a reduction in the book value of the asset
• Acquisition Cost (AC)

  • Price paid for the asset, INCLUDING taxes, delivery fees, installation, and any other expenses directly related to placing the asset into use.
• Useful Life/Estimated Life Span (ELS)

  • Number of years the asset is expected to be used in the business.
  • May be less than the potential life of the asset if it will be traded or sold before it is completely worn out.
• 3. Salvage / Scrap / Junk Value (SV)

  • Estimated market value of the asset at the END of its assigned useful life
  • Rule of thumb:
  • 5% of AC for tools/equipment;
  • 10% of AC for buildings, vehicles/machinery
  • Salvage Value (SV) ≥ 0
  • ↓ELS → ↑SV
• Total Depreciation (AC – SV)

  • loss in value expected over the useful life
• 5. Book Value (AC - AcD) (BV)

  
  

  Accumulated Depreciation
• 6. Accumulated Depreciation (AcD)

  • AcD involves all the depreciation from the purchase date to the current date
  • AC > BV ≥ SV
  • BV = SV at the end of the asset’s useful life
  • BV ≠ MV
• Depreciation Methods

  1. Straight Line Method
  2. Declining Balance Method
  3. Sum of the Years Digit Method
• Straight Line Method

  • Gives the same annual depreciation for each full year of an item’s life
  • Most applicable for properties that are constantly used, and provide a rather uniform flow of productive services over time regardless its age.
  • E.g. buildings, fences
• Declining Balance Method

  • Gives high values of depreciation in the first years (when the item is new) and lower values when the item is old.
  • Most applicable for properties whose market values decline most rapidly during the first few years of life and more slowly in the later years.
  • For properties that are more efficient when new than when old.
  • E.g. tools, equipment, machinery
• Sum-of-Years Digit Method

  • The annual depreciation is higher in the first year and declines by a constant amount each year thereafter.