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Depreciation
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Depreciation is essentially writing off the costs over the working life of your assets.
Different terms are used to describe writing off costs. ‘Depreciation’ is used for physical assets, ‘Amortization’ is used for intangible assets and ‘Depletion’ is used for natural resources. They are all essentially the same thing.
Methods of depreciation include:
The Straight-Line Method
An equal amount of depreciation for each year over the asset’s life.
Example:
An R10 000 asset with a five-year life span, no maintenance costs and no residual value.
Divide the depreciable base (the acquisition price plus maintenance costs less residual value) by the number of years of expected life span:
10 000 / 5 = 2 000 per year.
Sum-of-the-Year Digits
- Estimate the number of years of the asset’s useful life in reverse order (5,4,3,2,1)
- Add the reverse order years (5+4+3+2+1 =15)
- Divide each year by the sum (5/15; 4/15; 3/15, 2/15; 1/15)
- Multiply the depreciable base (acquisition cost plus maintenance costs less residual value) by each fraction above (for example, if the depreciable base is R10 000, then 10 000 x 5/15 = 3 333 for the first year and so on.)
Double-Declining Balance
- Calculate the straight-line depreciation
- Calculate the percentage depreciation in the first year and then double it. Using the same example, this would be 2000/10000 x 2 = 0.4 or 40%)
- Use this factor to calculate depreciation on the outstanding balance.
- Use the straight-line figure if the depreciation is higher when calculated using the straight-line method.
The following table illustrates the different depreciation methods:
|
Straight-line method |
Sum-of-years method |
Double declining balance method |
|||||||
|
Year |
Depreciation |
Net asset value |
Year |
Factor |
Depreciation |
Net Asset Value |
DDB calculation |
Depreciation |
Net asset value |
|
0 |
|
10,000 |
|
|
|
10,000 |
|
|
10,000 |
|
1 |
2,000 |
8,000 |
5 |
5/15 |
3,333 |
6,667 |
4,000 |
4,000 |
6,000 |
|
2 |
2,000 |
6,000 |
4 |
4/15 |
2,667 |
4,000 |
2,400 |
2,400 |
3,600 |
|
3 |
2,000 |
4,000 |
3 |
3/15 |
2,000 |
2,000 |
1,400 |
2,000 |
1,600 |
|
4 |
2,000 |
2,000 |
2 |
2/15 |
1,333 |
667 |
864 |
1,600 |
0 |
|
5 |
2,000 |
0 |
1 |
1/15 |
667 |
0 |
518 |
0 |
0 |
|
Totals |
10,000 |
|
15 |
|
10,000 |
|
9,222 |
10,000 |
|
Source: Stutley, R. 2007. The Definitive Guide to Business Finance. 2nd Edition. Prentice Hall. Pg 168
Click here to view a video that explains the two main methods of calculating depreciation.