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held assets - depreciation

5 August, 2015 - 14:41

There are several methods of depreciation available. The most easily understandable are straight line depreciation , and unit of use depreciation. They all share in common a target residual value in order to give depreciable amount, and the concept of useful life. Useful life can be thought of simply as time e.g. years, but in units of use depreciation, it can be number of units produced, number of operating hours, tons of raw material processed , etc. Another kind of depreciation is diminishing balance, where there is logarithmic rate of depreciation, e.g. a fixed % of the remaining balance of asset value after subtracting accumulated depreciation is determined to be the current period's rate of depreciation. This might be applied to an asset that exhibits greater ability for producing economic benefit when newer and more efficient.

If beginning with the concepts of useful life and residual value, the diminishing balance method can be easily expressed with the years-remaining-over-sum-of-years method, where the ordinal values of each year in the useful life is summed to give the denominator (e.g. 3 years useful life, 1 + 2 + 3 = 6), and the years remaining of life is the numerator, of the rate of depreciation for a given year (e.g. year 1 is 3/6, year 2 is 2/6, year 3 is 1/6). ( The rate of depreciation is applied to the initial cost of the asset, not the cost less accumulated depreciation).

When analysing income statements to determine cash flow, depreciation is a non-cash expense and should be added back in as it doesn't contribute to outflow of cash like other expenses do eventually.