What is Wasting Asset?
A wasting asset is a type of asset whose useful life is limited, and its value decreases over time, examples of which include fixed assets like vehicles, plant, property, and equipment or financial instruments like options.
Types of Wasting Assets with Formula
Now let us look at a different kind of wasting assets and how to calculate their decrease in value over a time period (also known as depreciation in some cases)
#1 – Factory/ Buildings / Office Furniture
These types of fixed assets are generally depreciated equally over their useful life. The straight-line depreciation method is used in this scenario. This is the simplest method of calculating depreciation, and the depreciation expense is the same each year evenly spread over the years. The formula used for calculating depreciation is
salvage value is the value (can be the selling value) of the asset at the end of its life.
Consider a building with an initial value of $1000 and a useful life of four years. Considering a salvage value of $200 at the end of its life, we can calculate the depreciation expense each year as (1000-200)/4 = $200 and can create a depreciation schedule as given in the following table.
#2 – Vehicles
Vehicles like cars, trucks are generally used very heavily in the initial years and, as such, should be depreciated rapidly in the initial years. We use the double-declining method in that case, which is very similar to the straight-line method apart from the fact that the depreciation rate is twice that of the first method. It assumes that the rate of depreciation of equipment is higher in the initial years as the machine is used more initially. The formula used for calculating depreciation is
Rate of depreciation = 100%*2/Useful Life
Consider a car with an initial value of $1000 and a useful life of four years.
In this method, the rate of depreciation is 2*100%/4 = 50% each year. So in the first year, the depreciation expense will be 1000*.5 = $500; in 2nd year, it will be $500*.5 = $250 and so on.
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In this method
Consider a car with an initial value of $1000, a salvage value of $100, and a useful life of four years.
So in the first year, the remaining years will be 4, and the sum of the years will be 1+2+3+4 =10, and hence the depreciation will be 4*(1000-100)/10 = $360.
#3 – Machinery
Machines/production equipment and the depreciation is calculated on the basis of the number of units produced and are depreciated by the Units of Production method.
Let us suppose a piece of equipment which produces five, six, four, and ten units respectively in the four years and has a salvage value of $100.
The depreciation expense for the first year would be given as 5*(1000-100)/(5+6+4+10)= $180 and so on.
#4 – Options
Enough of depreciation, we have completely ignored the other type of wasting asset called options, which we will describe in brief.
In layman, terms option is a type of instrument which allows the owner of the option to buy or sell a share at a certain price called the strike price. The price of an option depends on a few factors the most important of which are
- Difference between the strike price and the current price of the stock: This is because if for an example the buyer has the option to buy a share price $100 for $60 he is making a profit of $40 (the difference between the strike price and exercise price)
- The options have an expiry associated with them, after which the owner can no longer exercise it, and here comes the concept of time decay of options. The closer the options get to the expiry date, the lesser the probability of the owner making a profit, and finally, on the day of expiry, the value of the option becomes zero.
#5 – Natural Resource
Natural resources like petroleum reserves, coal mines, etc. are depleted over time based on the quantity extracted.
Consider a coal mine in which a mining company acquired for $10 million and used another $5 million to develop the site. Consider the mining company that can sell the mine after it has extracted the coal for a certain period for a residual value of $3 million.
Now consider the mining company plans to extract 1000 tons of coal from the mine.
Then the depletion per ton is (10+5-3)*10^6/1000 = $12,000
This is then multiplied by the tons of coal extracted per year to calculate the depletion expense per year.
If you can remember, this method is very similar to the method of units of production used for equipment described above.
Please refer to the above template for the detailed calculation of wasting assets.
Advantages of Wasting Asset
- The primary advantage of owning an asset is its ownership and the fact that owning an asset costs much less than leasing in the long run.
- Tax savings can be made by claiming depreciation against the equipment bought.
Disadvantages of Wasting Asset
- Buying an asset may not be possible for a business with low capital if the initial cost of an asset is high.
- The maintenance cost of an asset may be quite high, especially in the latter stages of its life.
Wasting assets are very commonly encountered in everyday life. In fact, most of the assets we can think of, a natural resource like petroleum, or a car, or even a life insurance policy, most of the assets depreciate in value with time and usage. It is up to the analyst to understand the asset and its usage to determine the method to decrease the value of the asset over time.
This has been a guide to what is wasting assets, and it’s a definition. Here we discuss types of wasting assets along with advantages and disadvantages. You can learn more about financing from the following articles –