We know depreciation is the fall in the value of fixed assets that are used in business operations. The calculation of the exact amount of depreciation is a troublesome process. It is generally based on estimations. However, efforts are made that estimated depreciation calculated is precise and exact. The given below are some factors that help in determining the actual amount of depreciation.
Determining the amount of depreciation
Cost of Asset: For the purpose of calculating the amount of depreciation, the total cost of the asset should be considered. All the expenses incurred in relation to acquiring, installing, and constructing an asset and bringing the asset into the usable condition are included in the total cost of the asset. Some of the examples of such costs are freight, installation cost, transit insurance cost, etc. An important point to be noted here is that the cost of assets never includes the financial charges such as interest on loans taken to purchase the fixed assets, etc.
Estimated Useful Life of Asset: Another factor determining the amount of depreciation is the estimated useful life of the asset. The useful life of assets may be in terms of a number of months, years, hours, units, etc. Every asset has its useful life other than its physical life. An asset may have a physical existence but may not be able to perform its functions. For instance, if machinery is purchased for carrying out business operations whose useful life is 10 years. But, it is expected to last only for 6 years. In such a case, the estimated useful life of the machinery will be considered only for 6 years and not 10 years.
Estimated Scrap Value: Scrap value is the residual value or salvage value that is expected to be realized from the sale of the asset at the end of its expected useful life. Before providing the depreciation, the scrap value should be deducted from the cost of the asset. This net value of the assets i.e. difference of the cost of assets and scrap value is considered as a base for charging depreciation. Algebraically, it can be written as Amount to be Written-off = Cost of Asset – Scrap Value For example, Furniture is acquired at a cost of Rs 2,00,000 with its effective life of 10 years. After 10 years, furniture is expected to realize Rs 20,000.
In this case, the cost of assets that should be considered for charging depreciation is Rs 1,80,000 (2,00,000 – 20,000). That is the cost after deducting its scrap value.
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