What is Depreciation and What Different Methods are Used?

• Depreciation matches asset cost to the periods benefiting from its use.
• Different methods produce different expense patterns and should reflect asset usage.
• Consistent policies and documentation improve auditability and comparability.

Why depreciation exists

Assets like machinery, vehicles, and equipment provide benefit over multiple periods. Depreciation spreads the cost so financial statements reflect that ongoing use rather than expensing the full cost upfront. Depreciation is non-cash, but it affects profit and (in many jurisdictions) tax calculations.

Common depreciation methods

Straight-line depreciation
Spreads the depreciable amount evenly over the asset’s useful life. It’s simple and widely used when the asset’s benefit is consistent each period.

Reducing balance (diminishing value)
Applies a fixed percentage to the asset’s carrying value each period, resulting in higher depreciation early and lower later. This may suit assets that deliver more value or incur more wear early on.

Units of production (usage-based)
Depreciation is based on actual usage (e.g., machine hours, kilometres, output). This fits assets whose consumption varies significantly by period.

What determines depreciation amounts

Key inputs include:

• Asset cost (including directly attributable costs)
• Residual value (expected value at end of life)
• Useful life (years/periods)
• Method selected
• Start date/capitalisation policy and period rules

Changes in estimates (useful life or residual value) should be documented, approved, and applied consistently.

Common mistakes and how to avoid them

Typical issues include incorrect start dates, inconsistent useful lives, forgetting disposals, or applying different rules across entities without a clear policy. A maintained fixed asset register with clear depreciation rules helps prevent misstatements and rework.

Does depreciation impact cash flow?
No, it’s non-cash, but it impacts profit and reported performance.

Can different assets use different methods?
Yes, when justified by usage patterns and applied consistently within categories.

What happens on disposal?
The asset and accumulated depreciation are removed, and a gain/loss is recognised.

Find out about Integrated Fixed Asset Register features available with AccountsIQ.

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