Depreciation Expense

Depreciation expense or DEPR is a fundamental concept in accounting and finance that is crucial in determining a company's financial health and performance. It refers to the systematic allocation of the cost of tangible assets over their useful lives. While depreciation expense is a non-cash transaction, it accurately reflects the actual value of assets and a company's profitability.

What is Depreciation Expense

3 Methods of Calculating a Depreciation Expense

• Salvage Value is the estimated value of the asset at the end of its useful life.
• Useful Life is the expected period over which the asset will be used.

Depreciation Expense = (Cost of Asset - Salvage Value) × (Units Produced / Total Expected Units)

How to choose the right depreciation expense method

• Consistency of Value : The straight-line depreciation method suits assets like buildings that maintain a consistent value over time. This method evenly spreads the expense across each period of the asset's life, making it ideal for long-lasting assets such as machinery and buildings. Short-term assets may require different depreciation methods.
• Initial Rapid Depreciation : Assets like vehicles often experience rapid depreciation in the first few years. In such cases, the declining balance depreciation method may be preferred. By adjusting the depreciation factor, this method reflects the asset's rapid loss of value, especially when the factor is greater than one. The declining balance method adjusts the asset's useful life annually due to accumulated depreciation.
• Value Loss through Use or Production : The units-of-production depreciation method is more appropriate for assets like production machinery. This method, commonly used in mining operations, calculates depreciation based on the asset's usage or production output. It allows for adjustments in depreciation expenses as production levels fluctuate.

Example Of Depreciation Expense

1. Straight-Line Method:

• Depreciable Cost: ₹100,000 (cost) - ₹20,000 (salvage value) = ₹80,000
• Annual Depreciation: ₹80,000 (depreciable cost) / 5 years (useful life) = ₹16,000 per year

2. Double-Declining Balance Method :

• Double-Declining Rate: (2 x 100%) / Useful life = (2 x 100%) / 5 years = 40% per year

3. Units-of-Production Method (Example with estimated units):

• Total Estimated Units: Assume the machine is expected to produce 100,000 units over its lifetime.