Within the context of accounting, depreciation refers to a physical asset’s loss of value over time. The loss of value over time for intangible assets (copyrights and patents) or natural resource assets (oil wells and gold mines) is referred to as amortization and depletion respectively. Also, land, while considered an asset, never depreciates. An asset depreciates because of wear and tear or obsolescence. Whatever the cause, there are two methods for determining the proper depreciation of an asset.
The first method is straight-line depreciation. This method assumes that the asset will lose an equal amount of value each year. To calculate how much the asset depreciates annually, you need to know three numbers: 1) the purchase price of the asset; 2) the salvage value, or estimated value of the asset at the end of its useful life; and 3) the estimated useful life, or the number of years you imagine it to be useful. To determine how much the asset will depreciate annually, subtract the salvage value from the purchase price and divide the difference by the estimated useful life. For example, a washing machine that is bought for $750 and expected to be worth $210 after 15 years of use will depreciate $36 annually.
The second method is unit depreciation. This method involves how much the asset is used over a period of time. For example, as the owner of a parcel delivery company, you decide to purchase a delivery truck on 1/1/2005 for $50,000. After some calculations based on maintenence and repair factors you determine that for every mile the truck is driven it will cost 10 cents in maintenence and repair. By 12/31/2005 the truck has been driven 20,000 miles. To calculate the truck’s depreciation that year, multiply 10 cents/mile by 20,000 miles. After one year, the truck that you bought for $50,000 has depreciated by $2,000. The next year you drive the truck only 10,000 miles so it depreciates only $1,000 that year. The accumulated depreciation on your truck is $3,000.
It is vital for individuals in any industry to understand asset depreciation and its attending factors. While land never depreciates, homeowners, potential buyers, investors, and real estate agents (link to: Become a Real Estate Agent landing page) need to know how homes appreciate and depreciate over time with the additional factor of an unpredictable real estate market at work.
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