What is depreciation?
Meaning of Depreciation
Depreciation consists of the loss of value of goods, land or real estate as a result of their use, the passage of time or technological aging.
This wear cannot be avoided and directly affects the useful life of the good or asset until it reaches the point where it becomes unusable and has no value.
Causes of depreciation
The main causes of the depreciation of assets are three:
1. Wear
It is the possible deterioration in the useful life of a good generated by the use that is given to it.
For example: a vehicle loses value since its parts deteriorate with its use, be it the engine, the wheels, the brakes, etc.
2. Obsolescence
This is caused by the passage of time and by the emergence of new, more modern and more efficient operating models.
For example: a computer loses value as faster, more capable and more modern equipment emerges over time.
3. Devaluation
This does not depend on the good, but depends on the country's economy, since the depreciation associated with devaluation is linked to the decrease in the nominal value of a national currency against a foreign currency.
For example: in a country with a high currency devaluation, imported equipment acquires a higher local value, but it depreciates due to its replacement capacity.
Depreciation Example
A good that suffers depreciation would be cars, which, according to numerous studies, depreciate every year by 10% of their original value. Although it is clear that it is not an exact science, it can serve as an estimate.
Methods for amortizing depreciation
Now, to avoid this problem of depreciation, companies calculate an estimated life of the good or asset and, based on that life, save a certain amount of money each year of the total value of the good so that when the good is already unusable they have money Saved for renewal. This is known as amortization and can be done in a variety of ways.
Among the most used methods we find two: the linear or fixed-rate method and the addition or accelerated depreciation method.
1. Straight-line amortization method
The straight-line depreciation method consists of depreciating the same amount of money each year of the useful life of an asset.
For example, if an airplane worth two hundred thousand euros is purchased and we believe that it will have an estimated life of ten years and that it will be worth nothing after that time, that is, it will have no residual value, according to this criterion, each year one tenth of the life of the equipment.
Thus, the annual amortization quota will be the result of dividing the two hundred thousand euros between the ten years that he will be in the company, giving us a amortization quota of twenty thousand euros per year. This amortization fee will be included as a cost of the company.
That is if, in the event that, after ten years, we are going to sell that plane for fifty thousand euros, for example, the amortization fee would be different since we would have to amortize only one hundred and fifty thousand euros, which is the result of subtracting the cost of acquisition the residual value. Thus, the annual amortization fee will be the result of dividing the one hundred and fifty thousand euros between the ten years that he will be in the company, giving us a amortization fee of fifteen thousand euros per year.
2. Accelerated or sum depreciation method
The addition or accelerated depreciation method consists of amortizing most of the asset in the first years of its life. To do this, the repayment installments start out very high, but decrease over time instead of being constant.
One of the most widely used formulas to speed up amortization is to amortize double the straight-line method in the first year.
In the previous example, if the plane lasted us 10 years and was worth nothing after that time, the first year of life instead of amortizing ten percent, we will amortize double, that is, instead of twenty thousand euros we will amortize forty thousand euros . In the second year, we will also amortize 20%, but since the amount pending amortization is one hundred and sixty thousand euros, which is the result of two hundred thousand euros minus the forty thousand euros of the first year, 20% of one hundred and sixty thousand euros will be amortized. are thirty two thousand euros and so on.
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