Depreciation Tools

Depreciation tools adjust the worth of assets.

Companies use depreciation to spread out the asset's value in reduction over its useful life. The value of any asset goes down with the passage of time, its constant usage and due to newer and more improved products being available in the market.



When companies provide for depreciation on their assets, they do not suffer mammoth losses when the assets actually stop working. There are several tools that companies can deploy to depreciate their assets.

Straight Line Depreciation

This tool depreciates the value of the asset by a constant sum each year. Whenever the asset is bought, the company fixes on the rate of depreciation, the sum of years it estimates the asset to be useful and the scrap value of the asset to be productive and useful. Then the value in reduction it spreads over its number of useful years.

For example, if the asset was bought for $6,000 and the company estimates it to be useful for 10 years, the rate of depreciation at 20 percent and the scrap value to be $1,000. The company after subtracting the scrap value from the asset's value, spreads the reduction value as $1,000 over the next five years.

Diminishing Value Depreciation

Companies use this depreciation tool to reduce the value of the asset as its book value at the start of the year. This tool works on the premise that the asset is likely to be used more and be more productive in its initial years rather than its latter years. Therefore the depreciation value should be greater initially. This tool is said to be an accelerated depreciation tool.

For example, if this asset too was bought for $6,000, the rate of depreciation is 20 percent, the scrap value is $1,000 and the number of useful years are five. Here, the first year depreciation charge would be $1,000, the second year charge would be $800, the third year would be $640 and so on.

Units of Production Depreciation

The assets are depreciated on the basis of its productivity in the business. In case the asset is employed more in production in the second year rather than in the first year, the depreciation value in the second year is higher than the first year depreciation.

The flaw here is that the asset, even without being used, might have lost value due to the availability of better products in the market. This factor is ignored here.

References

• Business Town: Depreciation
• College Cram: Depreciation Study Sheet