§ Not all equipment deteriorates equally e.g. a car, over its useful life.
§ Methods based on actual usage: total life are too cumbersome to be practicable
For Example: Say a machine costs Rs. 10,000 and Rs. 1,000 (as additional set-up/installation/maintenance expenses) = Rs 11,000 but we anticipate/guess its Kabari (Scrap Value) at Rs. 3,000 at the end of its useful life, of say, 10 yrs,
Cost of Machine + Installation + Directly Associated Costs = Total Cost
Total Cost - Salvage Value (At end of 10 yr. Period) = Depreciable base
10,000 + 1,000 =11000 (Total cost)
11000 – 3,000 = 8,000 as the Depreciable Base
Depreciable Base = Rs. 8,000, Spread out over 10 yrs = Rs. 8000/10(Yrs) = Rs 800/- depreciation per year.
This happens when we accurately assess asset life, but:
11,000 – 2400 = Rs. 8600 (book value) – 500 (salvage returns) = Rs 8,100 (loss).
Cost = 11000
Annual Depreciation = 800 x 3= 2400 = 8600 (Book value)
(Book value) 8600 – 500 (salvage value) = 8100 (Net loss)
Proportionate Annual Depreciation of Rs. 800 (8000 ¸ 10) is an example of the Straight Line Method of Depreciation.
· Written down value, applicable to machines that have high rates of depreciation in the initial year or two, and later taper it e.g. a car, is a usable method.
It can be of many types: For example,
EXAMPLE OF DOUBLE DECLINING BALANCE METHOD:
[The Double Declining Method takes an amount (usually double, i.e. 200% of the amount that we take in the Straight Line Method) and applies it to the book value of an asset each year]:
Suppose the asset costing Rs.16,000 has AN ESTIMATED USEFUL LIFE OF 5 YEARS, the depreciation
would be calculated as follows:
This example also shows accelerated, i.e. realistic, depreciation in early years of the machine's life, when its productivity/ book value is higher, as opposed to its fall in value in later years, and commensurate retarded depreciation.
Comparison of Methods of Depreciation:
· Many companies choose straight-line method for reporting depreciation to shareholders because net income is higher in early year.
· Because net income is lower in early years, some companies prefer the written down value method, especially for Income Tax purposes.