Factors Affecting the Amount of Depreciation: The calculation of the amount of depreciation for an accounting period is influenced by the:
- Actual cost of the asset
- Estimated residual or scrap value of the asset.
- Depreciable cost
- Estimated useful life of the asset
Out of these elements, two elements depend on just estimation and just one element depends on the actual cost. Therefore, computation of depreciation cost is only an estimated loss in value of assets and not the actual and precise decrease in estimation of an asset.
The various factors affecting the amount of depreciation are –
1. Actual cost of the asset: Cost (also known as actual cost or historical cost) means the acquisition cost of the asset and incorporates every single incidental expenses which are important to bring the asset to its current location and make it usable enough.
Instances of such costs are charges incurred in installation, freight inwards or costs incurred for improvements of such assets and which are of capital nature.For example, a printing machine is purchased for Rs.5,000 and Rs.500 is spent on its transportation and installation. In this case the original cost of the machine is Rs.5,500 (i.e. Rs.5,000 + Rs.500) which will be written-off as depreciation over the useful life of the machine.
2. Estimated residual or scrap value of asset: Net residual value also known as scrap value is the expected worth which might be acknowledged when the asset is sold or exchanged toward the end of its estimated useful life. At the point when residual value is significant, it ought to be taken into consideration for computing depreciation. Nonetheless, an insignificant residual value can be overlooked for calculation of depreciation.
Depreciation is a continuous cycle, however we don’t record depreciation every day. In reality, the aggregate sum of depreciation to be charged on any asset is an advance expenditure which has been paid by the enterprise at the hour of acquisition of such asset. In other words, this expenditure ought to be treated like deferred expenditure and just adjusting entries, for charging a sensible and appropriate amount of depreciation to revenue in the income statement, are required to be passed each year.
3. Depreciable cost: Depreciable cost of an asset is equivalent to its expense (as determined above) less net residual value. Hence, in the above example, the depreciable cost of the machine is Rs.4,500 (i.e., Rs.5,000 – Rs.500.) The depreciable cost is the value which can be distributed as depreciation expense over the useful life of the asset. In the above example, Rs.4,500 shall be charged as depreciation over a period of 10 years.
It is important to mention here that the total amount of depreciation charged must be equal to the depreciable cost. If the total amount of depreciation charged is less than the depreciable cost then the capital expenditure is under recovered. It is in violation of the principle of matching of revenue and expense.
4. Estimated life of the asset for which the asset will be used: Estimated useful life of the asset is either:
(I) The period over which a depreciable asset is relied upon to be utilized by the enterprise or,
(ii) The quantity of production or similar units expected to be acquired from the utilization of the asset by the enterprise.
For example, a machine is purchased and it is estimated that it can be used in the production process for 10 years. After 10 years the machine may still be in good physical condition but can’t be used for production profitably as the cost of production would be very high. Therefore, the useful life of a machine is considered as 10 years irrespective of its physical life.
Thus, there are various factors affecting the amount of depreciation ranging from cost of asset to its net realisable value.