What is the Depreciation Rate?
The depreciation rate is the percentage rate at which an 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 that the company claims as a tax-deductible expense across the asset’s useful life. It is different for each class of assets.
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Depreciation Rate Formula
The most widely used method of depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. is the straight-line methodStraight-line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. . This rate is calculated as per the following formula:
Depreciation Rate per year: 1/useful life of the asset
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 for the asset if any.
- The useful life of the asset: Useful life of the asset is the 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 respective revenue authority defines the useful life of a few assets like computers, real estate, etc. For example, computers are depreciatedComputers Are DepreciatedDepreciation for computers means an amount written-off from the cost of computers each year equally or calculated by an enterprise over the useful life of computers to change them. It refers to reducing or providing an amount to decrease computers' value and report profits accurately. over five years, while vehicles are depreciated over eight 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 valueScrap ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000..
Depreciation Rate Explained in Video
Below are some of the examples to understand this concept better.
- Cost of a Vehicle: $5,00,000/-
- Scrap Value of Machine: $50,000
- The useful life of asset: 5 years
Depreciation rate formula: 1/5 = 20%
- Depreciation value per year: (500000-50000)/5 = 90,000
- Thus depreciation rate during the useful life of vehicles would be 20% per year.
A company purchases 40 units of storage tanks worth $1,00,000/- per unit. The company uses a Double declining method of depreciationDouble Declining Method Of DepreciationThe Double Declining Balance Method is one of the accelerated methods used for calculating the depreciation amount to be charged in the company's income statement. It is determined by multiplying the book value of the asset by the straight-line method's rate of depreciation and 2 method to calculate the tank’s depreciation expense. Tanks have a useful life of 10 years and a scrap value of $11000/-.
- 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 valueSalvage ValueSalvage value or scrap value is the estimated value of an asset after its useful life is over. For example, if a company's machinery has a 5-year life and is only valued $5000 at the end of that time, the salvage value is $5000. at the end of 10 Years.
For 40 units, the depreciation table will be as follows:
*Book value is for 40 unit
# Depreciation expense for the Year 2028 is kept at $96,871 to maintain the residual valueResidual ValueResidual value is the estimated scrap value of an asset at the end of its lease or useful life, also known as the salvage value. It represents the amount of value the owner will obtain or expect to get eventually when the asset is disposed. at the end of 10 Years.
- It helps to spread the cost of an investment in fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. across the asset’s useful life. 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, thereby reflecting the wear and tear the asset might have had on the basis of the number of years it has been used for.
- It helps to generate tax savings for the company.
- It is usually considered constant for the particular class of assetClass Of AssetAssets are classified into various classes based on their type, purpose, or the basis of return or markets. Fixed assets, equity (equity investments, equity-linked savings schemes), real estate, commodities (gold, silver, bronze), cash and cash equivalents, derivatives (equity, bonds, debt), and alternative investments such as hedge funds and bitcoins are examples. and hence reflects the estimated depreciation value every year. The useful life of an asset and hence depreciation depends on many other factors like how an asset is handled, the number of hours it is operated for, the quality of parts of assets, etc., which are not reflected in the 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.
The depreciation rate is used by the company for the calculation of depreciation on the assets owned by them and depends on the rates issued by the Income-tax department. Poor calculation methods may distort both the Profit and Loss statement and Balance sheet of the companyBalance Sheet Of The CompanyA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.. Hence a fair understanding of the same is very important.
This has been a guide to Depreciation Rate and its definition. Here we discuss its Depreciation Rate formula, its calculations, and practical examples. You may learn more about accounting from the following articles –