Depreciation

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Depreciation :
Depreciation is a term used in accounting, economics and finance with reference to the
fact that assets with finite lives lose value over time.
There are several methods for calculating depreciation, generally based on either the passage of time or the level of activity (or use) of the asset.

- Straight-line depreciation : Straight-line depreciation is the simplest and most often used technique, in which the company estimates the "salvage value" of the asset after the length of time over which it is depreciated, and assumes the drop in the asset's value is in equal, constant yearly increments over that amount of time.
The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero.
For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000,
and will have a "salvage value" of US$2000 will depreciate at US$3,000 per year. ($17,000 - (5 x $3000)) = $2000 In other words its the cost of the assets divided by number of year of its useful life.
If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess depreciation would be considered as income by the tax office (capital gains). If the sales price is less than the book value, the resulting capital loss is tax deductible.
If a company chooses to depreciate an asset at a different rate from that used by the tax office then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit.

- Sinking fund method : A method of depreciation under which the depreciation expense is an amount of an Annuity so that the amount of the annuity at the end of the useful life would equal the Acquisition Cost of the asset.
Theoretically, the depreciation charge should include interest on accumulated depreciation at the beginning of the period. This method is rarely used in practice. The sinking fund method allocates more depreciation to the later years.
The depreciation for the first year equals the annual deposit needed for a sinking fund to accumulate at the given rate to an amount that equals the depreciation base.
Then for each consecutive year, the annual depreciation equals the annual sinking fund deposit plus the interest earned on the fund up to that year.

- Declining-balance depreciation : As declining-balance method is a type of accelerated depreciation, because it recognizes a higher depreciation cost earlier in an asset's lifetime. This may be a more realistic reflection of an asset's actual resale value, as well as the expected benefit from the use of the asset: many assets are most useful when they are new.
In the U.S., a form of double declining-balance depreciation, MACRS, is used for tax purposes and is based on time.
In declining-balance depreciation, each period's depreciation is based on the previous year's net book value, the estimated useful life, and a factor. The factor is commonly two; this is known as double declining-balance.
Each period we calculate depreciation:
For the double-declining balance method, using the vehicle example from above, we compute the depreciation after the first year:
We subtract $6800 from our previous year's net book value to obtain our new net book value . For the second year, we use this new value to calculate depreciation.
Notice that it is significantly lower than the first year.
This process continues until we reach the salvage value or the end of the asset's useful life. Since declining-balance depreciation doesn't always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life.
It should also be noted that the book value of the asset being depreciated is never brought
below its salvage value, regardless of the method used.

- Activity depreciation : Activity depreciation methods are not based on time, but on a level of activity. This could be miles driven for a vehicle, or a cycle count for a machine.
When the asset is acquired, we estimate its life in terms of this level of activity.
Assume the vehicle above is estimated to go 50,000 miles in its lifetime.
We calculate a per-mile depreciation rate:
($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30 per mile.
Each year, we then calculate the depreciation expense by multiplying the rate by the actual
activity level.