Depreciation is a financial instrument that is used to assess the value of assets.  Such assets could be tangible, intangible or natural resources.  It is indisputable that when one acquires an asset, it either depreciates or appreciates in value over time.  One thing worth noting is that depreciation is a process of cost allocation not of asset valuation.  Depreciation can result from physical deterioration or obsolesce or both.  There however is something amiss about depreciation.  I think depreciation only exists in theory but not in practice.

 

There are three elements of financial measure that are required to calculate depreciation.  It is the cost, estimate residual value and estimated useful life of the asset.  There is a lot of components that go into cost components needed for calculating depreciation.  For example, it is acceptable to include surveying, clearing, grading the property and fencing into the cost of acquiring a piece of land.  Estimate residual value is the money for which the asset can be sold for after the expected lifetime of the asset.  For example, a building is expected to give service to the owner for about 35 years.  Each year of the 35, the asset is assumed to be depreciating.

 

Applying depreciation to business transforms the cost of assets into expenses that go into the balance sheet.  In the balance sheet, assets are indicated as financially evaluated and having a book value.  The book value calculations give an estimate sport value of an asset when depreciation has been removed.  In other words, it is the salvage value of an asset at any given time.

 

There are several methods of calculating depreciation. There is one that is called rate depreciation and another one called accelerated depreciation. These two are the most used in businesses today. They will tell you that a car bought for $ 0.5 million will depreciate to less than $ 50,000 in 5 years, which is not likely to be a true salvage prize in five years.  In actual fact, the deceit is in the salvage price.

 

Depreciation is funny because as an asset ages, there comes a point where it doesn’t apply.  Accountants will tell you that no matter how good the condition of the asset (in a position to depreciate further when assessed by mere looking), if the estimated lifetime of the asset is over, depreciation doesn’t apply. The reverse is true, when an asset seems to be in a state where it cannot depreciate any further, if its lifetime hasn’t lapsed, depreciation still apply.  Maybe I need to be correct on this one, but as far as I’m concerned, this is true.

 

Be warned, this is the major playground for accountants, bankers, attorneys, estate agents, businesses, governments and international institutions to take advantage of you the buyer.  Normally, you’d find yourself in the instance of having to calculate depreciation of an asset before you dispose it.  Without proper knowledge, you can be cheated into settling for a low salvage price yet you could capitalize and get more for it if you take time to learn the tricks of the game.  My advice, is that you consult an expert in the field of accounting and this consultant of yours should not be in the picture on the transaction process.

 

Good luck, just a wake up call to equity owners. Do your assignment or you may end up regretting lost opportunities or worse, be taken advantage of. 

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