There are multiple methods that are associated with getting the correct rate of charge for a depreciation value. This Straight line or Equal installment or depreciation on original cost as it is stated is surely the most important and easiest way to get the actual rate of depreciation.
Rate of Depreciation:
Original cost of the asset/Estimated life period of the asset.
Example: Let us take value of an asset to be at $20,000 for a period of 10 years. In such a scenario, amount of depreciation that is charged is taken at,
20,000/10 = $2000. So it can be stated that for that particular capital for a period of 10 years, depreciation rate is to be fixed at $2,000.
Hence, when a graphical representation of this same is done, it can be taken to be a straight line since every year amount of depletion is kept at $2,000.
At times, scrap value that is also known as residual value is given as well. This implies that amount that is taken as proceeds from sale of that obsolete vehicle.
Since under this straight line depreciation, depreciation can also be found by applying a fixed rate to that original cost of the asset.
Going by the formula,
Annual Depreciation = (Cost of asset – Scrap/Salvage/Breakup/Residual value)/Expected life of that asset.
Details associated with the formula:
It is quite natural that every asset or capital that is acquired for production would have a fixed lifetime span within which it would function in the beat manner. Whenever, any seller sells such product, its estimated life is stated in terms of years, tons or distance that it can cover. In case it is not mentioned, an approximate value can be taken based on past experience.
This is the original cost that is associated with acquiring of that particular asset. This includes a number of important points as, cartage and freight costs for getting it to the desired place, in case of any building the construction charges are taken into consideration as well as installation charges. A compilation of all of these is taken as total cost of the assets.
After a certain point of time, every asset loses its actual productive value due to depreciation, and therefore it becomes obsolete from company’s point of view. This asset when sold, proceeds from this are known as scrap value.
A detailed understanding of these factors is important to ensure that there is no mistake in calculation.