What is Depreciation Rate?
The depreciation rate is the percent 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 asset.
Depreciation Rate Formula
Most widely used method of depreciation is the straight-line method. 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 etc. for the asset if any.
- The useful life of 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
Below are some of the examples to understand this concept better..
Example #1
- 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 vehicle would be 20% per year.
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 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.
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 value at the end of 10 Years.
Advantages
- It helps to spread the cost of an investment in fixed asset 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 asset 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, a number of hours it is operated for, quality of parts of assets, etc. which are not reflected in depreciation rate usually.
- For assets like IT asset, which are upgraded from time to time, it is difficult to ascertain the actual depreciation rate since the value of asset varies in the middle of the useful life of asset 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.
Depreciation Rate Video
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