What Is Depreciation?

Every asset depreciates over time. Here's how depreciation for different assets are calculated for accounting and tax purposes

Depreciation indicates a reduction in the value of an asset over time. Typically, it occurs due to wear and tear of the asset over time as a result of continued use to calculate the depreciation of an asset, one needs to consider several factors, one of which is the useful life of the asset. For instance, the usable lifespan of a laptop or a smartphone might be limited to 4-5 years. For accounting and tax purposes, assets are divided into several classes, based on their useful life expectancy.

Any asset that helps in generating income or saving costs, such as property, automobiles and equipment, is subject to depreciation.

How to calculate it?

• Under the Companies Act, 1956, two methods (Straight Line and Written Down Value) are used based on the specified rates.
• Under the Companies Act, 2013, three methods are used based on the useful life of assets. These includes the two aforementioned methods and the Unit of Production Method.
• As per the Income-tax Act, 1961, based on the specified rates, Written Down Value Method (Block wise) and Straight Line Method for Power Generating Units are used.
• The formula for depreciation is: Depreciation basis = (cost of the asset) – (remaining value after the end of its useful life).

Depreciation of Cars

• In the case of general insurance, to replace a damaged part of a car due to natural or man-made causes, insurance companies consider depreciated value of the part while settling the claim.
• In the case of zero depreciation insurance (available for cars as an add-on cover in India), the full value of the damaged part is given by some insurance companies without taking into account the depreciation.
• Generally, insurance companies allow only two zero depreciation claims during the policy tenure.
• The Insurance Regulatory and Development Authority of India (Irdai) has uniform depreciation rates for cars.

How to deal with it?

• It is possible that assets depreciate quickly even though the depreciation period for such assets might be longer. For instance, computer equipment are usually written off in five years, but you may consider replacing it before that if you think that it will become obsolete sooner than later.
• However, a real estate property may not depreciate for years. Thus, one has to have strategic foresight while dealing with real estate depreciation. The real estate owner must take an innovative approach to deal with it. For example, property renovation, its adaptive reuse, and targeted marketing can help in putting some breaks on the pace of depreciation in the property value.