33.4 Depreciation

Why do assets depreciate?

1. Wear and tear: repeatedly using an asset can cause them to fall in value and maintenance costs will rise

2. Technological change: new technologies will make old ones obsolete and fall in value

Depreciation

The process of allocating the cost of a non-current asset over its useful economic life. Depreciation is recorded as an expense and reduces profit.

Formula (annual depreciation): (original cost of the asset - expected residual value) / expected useful life of the asset (years)

Net book value

A figure representing the value of an asset that is recorded on the accounting records.

Formula: original cost - accumulated depreciation

Straight line method

A method of calculating the depreciation cost of an asset over its useful life that assumes the cost of an asset is spread over its useful life. It also assumes that the asset will have a residual value (resale value).

• Easy to calculate and understand

• Relies on accurate estimates

• Doesn't account for usually increasing maintenance costs and fluctuating depreciation charges.

Formula: (original cost of the asset - residual value) / estimated useful life of asset

Residual value/Salvage value

The estimated value of an asset at the end of its useful life.

Impact of depreciation on the financial statements

1. The profit from operations will decrease because depreciation charge is accounted for as an expense

2. The net book value of non-current assets will decrease