fbpx Skip to main content

Depreciation is something that is happening all around us, all of the time, whether we know it or not.

Do you drive a car? If so, every time you get in your car and drive, the value of the car depreciates. 

In fact, as soon as you buy a car and drive it off the lot, the car value depreciates.

According to Carfax:

‘Our data shows that cars can lose more than 10 percent of their value during the first month after you drive off the lot… According to current depreciation rates, the value of a new vehicle can drop by more than 20 percent after the first 12 months of ownership.’

Essentially everything goes through depreciation at some point. 

Whether it be a car, computers, equipment, or anything that can be considered old, obsolete, or not functioning at some point, those assets fall into that unfortunate bucket of value loss.

What is Capital Depreciation?

Capital depreciation is the overall decline in usefulness, or value, of an asset over time.  

This is a term that is used mostly for accounting purposes by companies, businesses, and other institutions in order to calculate expenses and asset value and loss over time. 

In understanding what capital depreciation means and how it applies to assets, we can start by using a simple scenario. While depreciation can occur in different ways, here’s an example of depreciation due to the usage of an asset.

Take a mechanical pencil for example. 

Mechanical pencils require lead in order to write. Without lead, you’re just left with a cheap piece of plastic.

The lead, in this example, is what’s considered the asset.

The asset is the use of the lead to provide a value. In this case, the value is being able to use the lead to write.

When you write something on paper, this utilizes the lead in the mechanical pencil cartridge. 

Over time, after using the pencil to write, the piece of lead gets smaller and smaller until there is nothing left. 

The lead, as the tangible asset, represents the capital depreciation.

Causes of Depreciation

Depreciation can occur in various ways.

  1. Depreciation due to the usage, or physical condition of the asset. As we all know, nothing lasts forever. In theory, the more something is used, the more wear and tear the asset experiences and therefore reduces the overall value over time.
  2. Depreciation due to obsolescence. When a computer is bought one year, it may be already an older model by the next year, let alone obsolete in 5-10 years’ time. The longer time goes on, despite the factor of wear and tear and usage, assets will become obsolete. It all comes down to a matter of time.
  3. Depreciation due to change in market demand. When an asset has a decreased demand, the value of the asset will take a hit.
  4. Depreciation due to the resale value of the asset. We can look at the earlier example of the new car getting driven off the lot and experiencing value loss. Not only with cars, but with any kind of asset that could be re-sold.

What is Capital Depreciation Rate?

Capital depreciation is the asset’s overall decline in value during its lifespan.

For example, if a company purchased a piece of equipment for $50,000 and has a lifespan of 10 years, the value would decline by $5,000 every year. After 1 year, the value would be $45,000. After 2 years, the value would be $40,000, and so on.

What is Depreciation Rate?

Depreciation rate is calculated a bit differently than capital depreciation, whereas this is the amount, represented by a percentage, that is depreciated on a yearly basis from the asset.

For example, if a business owns a piece of equipment, or what is considered the asset, and that asset had a $50,000 worth of depreciation over it’s lifespan with a $5,000 yealy depreciation, the depreciation rate would be 10% annually.  

Not all depreciation rates are the same either, they are calculated differently for asset classes.

Depreciation Methods

There are various types of depreciation methods:

  1. Straight Line Depreciation – Straight-line depreciation, or straight-line basis, is an expected depreciation that remains constant throughout the lifespan of the asset.
  2. Double Declining Balance Depreciation – Double declining balance depreciation, or the reducing balance method, is a type of value loss that is accelerated in the earlier years of the lifespan of the asset because the expense is higher during that time. One benefit here is that this type of depreciation allows for increased tax deductions in the earlier years, as opposed to the later years.
  3. Units of Production Depreciation – The units of production depreciation method, or the units of activity method, can be ascertained that the value of the asset is related to its overall usage throughout its working years, rather than time being a reason for value decrease.
  4. Sum of Years Digits Depreciation – The sum of years digits depreciation, or known as the acronym SYD, is a quantitative method that uses the expected life span of the asset and then adding those numbers up. For example, if the expected life span for an asset were 7 years, you would simply add 1+2+3+4+5+6+7, which equals 28. Each of these individual digits is divided by the sum of the amount, which in this case would be 28, in order to determine the percentage of depreciation per year.

Depreciation Period

The depreciation rate of the asset is determinent on how many years, or the lifespan, that the asset with be used for a business. The depreciation expense, in most, cases, begins when the asset begins it’s service, or ususally when it starts creating value.

Various assets hold differing years of value life. 

According to the Federal Reserve, the average depreciation rate over a five-year period of a personal computer is 40%.

Also, according to Investopedia, “most residential rental property is depreciated at a rate of 3.636% each year for 27.5 years. Only the value of the building can be depreciated; you can’t depreciate land because it will never be “used up.””

This goes to show that depreciation is different for all kinds of assets.  It’s important to understand what the the capital depreciation of your assets will be, depending on your business, in order to keep your finances and expenses in order. 

Back Bay Investment Group is a real estate investment platform specializing in real estate syndication & crowdfunding. Our award-winning investment services aim to acquire, develop, and help you monetize your assets. When you invest with us, you invest with confidence. Contact us today for more information.

Author admin

More posts by admin