Fundamentals of Business

Depreciation

Depreciation is a term used in economics and finance with reference to the fact that assets with finite lives lose value over time. In accounting, depreciation is a term used to describe any method of attributing the historical or purchase cost of an asset, across its useful life, roughly corresponding to normal wear and tear.

Calculations Straight line depreciation where equipment depreciates by a constant amount over a period.

Think of co-ordinate geometry
Straight line equation is represented by
y = mx + c
where m = slope or gradient, a constant where c is y intercept, the point where the line crosses y axis Looking at the graph above y intercept is equal to the brand new price
gradient = change in price/change in time = constant amount of depreciation Since depreciation is reduction in value, then gradient is negative

Therefore
Straight line equation will be
y = c -mx equation 1

Suppose
An equipment price when is new = P
The constant amount it depreciates = m
Replacing c on equation 1 by P
y = P -mx

This is the formula for calculating depreciation based on straight line.
Where y = remaining value
x = period

Example
A brand new Lexus costs £40,000, and depreciates by £5000 annually.
It has 60,000 miles five year warranty. How much will it be worth at the end of the warranty? Solution Identifying the variables y =P - mx
Brand new price P = £40,000
Depreciation m = £5000
time in years x = 5
Therefore
Value at the end of the warranty = 40,000 - (5000 x 5) = £15,000