Depreciation

What is Depreciation?

Depreciation refers to the decrease in value of an asset over time. It is an accounting technique that allows businesses to distribute the cost of an asset over its lifespan. Accountants record depreciation for assets that have not been fully depreciated at the end of an accounting period. 

Types of Depreciation

1. Straight-Line

This method divides the cost of the asset, less the salvage value, by the asset's lifespan, resulting in equal annual depreciation. 

1. Declining Balance

This accelerated depreciation method involves calculating depreciation using a straight-line depreciation percentage on the asset's book value. 

1. Double-Declining Balance (DDB)

This method uses twice the rate of the straight-line depreciation applied on the asset's book value. 

1. Sum-of-the-Years Digits (SYD)

This method uses the digits of the asset's projected lifespan to calculate depreciation. 

1. Units of Production

This method requires an estimate of the total units an asset will produce over its lifespan, with depreciation cost computed annually based on units produced. 

Assets Subject to Depreciation

1. Owned by you

2. Used in your business or income generation

3. Have a predetermined lifespan

4. Expected to last more than a year

Advantages of Charging Depreciation

1. Depreciation is tax-deductible and should be calculated for accurate tax liability. It must be included in financial statements according to legal regulations.

2. If depreciation is not accounted for, profits may appear high, potentially leading to redistribution of profits leaving the business short on cash for asset replacements.