Depreciation is one of the most talked about topics when it comes to investment property. This is no surprise as every investor and owner will want to make sure that the value of their assets are preserved or at least used to their maximum capacity.
This is why today we’re giving you a little rundown on the basics of asset depreciation. It never hurts to learn a thing or two about how these assets are accounted for. Knowledge is power after all, right?
There are many ways to define and explain depreciation and here are a few of them.
- It refers to the amount or percentage by which something decreases in value over time.
- It is a decrease in the value of a fixed asset with the passage of time due in particular to wear and tear.
- It is that portion of an asset which is expected to be used for a long period of time but is not meant to last forever that is reported as an expense in the income statement and is a deductible item for tax purposes.
There are a number of methods by which an investment property is to be depreciated. Each alternative has its pros and cons and is beneficial given specific circumstances. It is best to talk to your accountant when about these.
- Straight Line– Considered to be the simplest and widely used method, this charges an equal amount of depreciation expense for every period. It is simply calculated as the book value less salvage value all over the remaining useful life.
- Units of Production– This charges an equal expense for each unit rendered by the asset. It is best used for assets that are not in continuous use and when the property’s value is more closely related to the number of units it produces than the number of years it is in use.
- Sum of the Years Digits– This is an accelerated depreciation technique that is based on the assumption that a property is generally more productive when it is new and its productivity decreases as it ages. It is computed by multiplying the asset’s depreciable cost by a series of fractions based on the sum of the asset’s useful life digits.
- Double Declining Balance– Another of the two types of accelerated methods; this calculates a depreciation expense in the first years of a property investment’s life and then it gradually decreases in the succeeding years. It is used for when the functionality of the asset is consumed in rapid rates during its initial useful years and/or when there is intent to recognize more expense today so as to use it for deferring income taxes.