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You can depreciate tangible, long-term property that you use for business operations. The
property must be a physical object that you can see and touch. And, the property must last
more than one year at your business. Usually, you must own the property to depreciate it.
You generally can't deduct in one year the entire cost of property you acquired, produced, or
improved and placed in service for use either in your trade or business or income-producing
activity if the property is a capital expenditure. Instead, you generally must depreciate such
property.
Useful life is the estimated lifespan of a depreciable fixed asset, during which it can be
expected to contribute to company operations. This is an important concept in accounting, since
a fixed asset is depreciated over its useful life.05-Feb-2022
The depreciation rate is the percentage rate at which asset is depreciated across the estimated
productive life of the asset. It may also be defined as the percentage of a long-term investment
done in an asset by a company which company claims as tax-deductible expense across the
useful life of the asset. It is different for each class of assets.
The most widely used method of depreciation is the straight-line method. This rate is calculated
as per the following formula:
Depreciation Value per year = (Cost of Asset – Salvage value of Asset)/ Depreciation Rate
per Year
Cost of asset: It is the initial book value of the asset. It includes taxes paid or shipping
charges paid etc. for the asset, if any.
The useful life of the asset: Useful life of the asset is the time period for which an asset
can function properly. Beyond the useful life, the asset is deemed to be cost-ineffective
or not fit for operation/usage. The useful life of a few of the assets like computers, real-
estate, etc. is defined by the respective revenue authority. For example, computers are
depreciated over 5 years, while vehicles are depreciated across 8 years.
Salvage Value: Value of asset after the useful life of the property at which the company
may sell the asset. It is also known as scrap value.
Examples
Example #1
Example #2
A company purchases 40 units of storage tanks worth $1,00,000/- per unit. Tanks have a useful
life of 10 years and a scrap value of $11000/-. The company uses a Double declining method of
depreciation for calculating the depreciation expense for the tanks.
Thus,
The formula as per the straight-line method: 1/useful life of asset = 10%
Depreciation period Double Decline Method: Rate as per straight-line method * 2 = 10%
* 2 = 20%
Depreciation for subsequent years (considering storage tanks are bought at the start of FY19) is
as follows:
*Depreciation expense for the Year 2028 is kept at 2422 to maintain the salvage value at the
end of 10 Years.
Advantages
It helps to spread the cost of an investment in fixed assets across the useful life of the
asset. This way, the company does not have to account for the cost in the first year, else
the company will have to suffer losses in the year of purchase.
It helps provide the correct market value of assets,s thereby reflecting the wear and tear
the asset might have had basis the number of years it has been used for.
It helps to generate tax savings for the company.
Limitations
It is usually considered to be constant for the particular class of asset and hence reflects
the estimated value of depreciation every year. The useful life of an asset and hence
depreciation depends on many other factors like the way an asset is handled, the
number of hours it is operated for, the quality of parts of assets, etc. which are not
reflected in depreciation rate usually.
For assets like IT assets, which are upgraded from time to time, it is difficult to ascertain
the actual depreciation rate since the value of assets varies in the middle of the useful
life of assets, subsequently changing the useful life of an asset. This further complicates
the calculation.
Conclusion
Depreciation Rate is used by the company for calculation of depreciation on the assets owned
by them and depends on the rates issued by the Income-tax department. Poor methods of
calculation may distort both the Profit and Loss statement and Balance sheet of the company.
Hence a fair understanding of the same is very important.
Market approach