Concept of depreciation

Depreciation is the decrease in the value of a property or asset with the passage of time, caused by ageing, wear and tear, decay, weathering, obsolescence and similar causes. It is the loss in value from the original cost to the scrap or salvage value at the end of the useful life.

Causes

• Physical wear and tear, use and decay.
• Weathering and the action of the environment.
• Obsolescence: old design, change of fashion or technology.
• Accident, fire or earthquake damage.
• Lack of maintenance; legal restriction.

Land does not depreciate (except in special cases such as mines); buildings, machinery and equipment do.

Methods of calculating depreciation

1. Straight line method: the same amount each year. $D = \dfrac{C - S}{n}$, where C is the cost, S the scrap value and n the life in years.
2. Constant percentage (declining balance) method: a fixed percentage on the reduced book value each year; the depreciation is larger in the early years.
3. Sinking fund method: a yearly amount is invested at compound interest so that at the end of the life it equals the (C − S): $I = \dfrac{(C-S)\, i}{(1+i)^n - 1}$.
4. Quantity survey method: the building is divided into parts and the depreciation of each part is estimated separately by its life.
5. Depreciation by the age and life ratio (value method).

Depreciation is used in valuation to find the present value of a building, in accounts, and for deciding replacement.