Year Depreciation Allowance
Depreciation is a non-cash expense. This makes it difficult for many people to conceptualize. However, it is a simple accounting convention that is used to help accountants track the use of assets over time. It is also used to write off the value of the asset against income. For this reason, companies are only allowed to depreciate a certain portion of an asset's value every year.
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Depreciation Methods
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There are many different ways to calculate depreciation allowance. This is because assets are used and lose value in different ways. That is, an asset's current value is dependent on its usage, the situation and the type of asset being used. Depreciation expense is calculated based on certain variables. The primary variable is the original cost of the asset. The second and third variables are the salvage value of the asset and the useful life of the asset.
Straight-line Depreciation
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Straight-line depreciation allowance is calculated by subtracting the salvage value of an asset from the original cost of the asset and then dividing this number by the useful life of the asset. The straight-line method, unlike some other methods used, expenses the same amount of depreciation every year of the asset's useful life until it is fully depreciated.
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Depreciation Variables
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It's easiest to understand depreciation variables through a relative example. For instance, assume you purchased a tractor trailer for your business. The trailer has an original cost of $10,000. This is the price you paid for the trailer, not the value of the trailer. According to the user manual and the dealer, the trailer is expected to operate for four years. That is, the trailer is expected to provide value and generate income for the company for four years. At the end of the four years the trailer should be fully written off. The local scrap yard will buy the trailer parts for $2,000. This is referred to as the salvage value of the trailer.
Calculating Depreciation Allowance
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Using the previous example, the depreciation allowance is calculated by subtracting the salvage value of the trailer from the cost of the trailer. The calculation is $10,000 minus $2,000 or $8,000. The depreciation allowance is then calculated by dividing this number by the useful life of the asset, which is four years. The answer is $2,000. That is, you are allowed to write off $2,000 from your income every year for depreciation allowance associated with the purchase of the trailer.
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