How to Calculate Depreciation – Complete Methods & Formula Guide

2016

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2016

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2. Written Down Value (WDV) Method (Faster Early Loss)

• Higher depreciation in the early years
• Common for electronics, vehicles
• Formula:
• Current Value × Fixed Percentage (e.g., 20%)

Calculation (20% rate):

3. Units of Production Method (Based on Usage)

• Depends on how much the asset is used.
• Good for factory machines, vehicles.
• Formula:
• (Cost - Salvage Value) ÷ Total Expected Usage.

Example: If a car lasts 2,00,000 km:

(₹10,00,000 - ₹2,00,000) ÷ 2,00,000 = ₹4 per km

If Nitin drives 20,000 km/year:

20,000 × ₹4 = ₹80,000 yearly depreciation

Which Method to Choose?

• Straight-Line: Simple, equal expenses (buildings, furniture).
• WDV: Fast-depreciating items (cars, phones).
• Units of Production: Usage-based (taxis, factory machines).

Nitin can pick the method that best matches his car's use and business needs.

How does Depreciation Affect Taxes?

Depreciation helps save taxes by reducing your business profits on paper. Here's how it works for Nitin:

• Nitin's Taxi Business
  
• Bought a car for ₹10,00,000 in 2015.
• Uses straight-line depreciation (₹80,000 per year).
• After 5 years, total depreciation claimed: ₹4,00,000.

• Tax Savings
• Without depreciation, Nitin's business shows ₹5,00,000 profit.
• With depreciation: Profit reduces to ₹4,20,000 (₹5,00,000 - ₹80,000).
• Lower profit = Lower tax payment.

• Key Points
• Depreciation is a "paper expense" - no actual cash leaves your pocket.
• The government allows this deduction to encourage business investments.
• Different assets have different depreciation rates (cars, machines, buildings).
• Must use approved methods (like straight-line or WDV) for tax filings.
• If you sell the asset later, tax rules adjust for the depreciation claimed.

Each year, Nitin pays less tax since the depreciation makes his company’s earnings look less, helping him save money towards a new car. With this benefit, companies can acquire business assets more easily as time goes by.

Conclusion

It is similar to your car getting less valuable over time, though your business. Choose Nitin’s taxi because it was bought for ₹10 lakhs; each year, ₹80,000 is lost in paper value. The pay expenses, not real money taken from his pocket. So far, he’s used ₹4 lakhs from his business income to buy his next car and has set aside that amount, avoiding tax on it. 

Also Read – How to Calculate Company Valuation – Step-by-Step Guide

A straight-line method is simple, but WDV gives tax savings at the beginning of the ownership. The main idea is that depreciation gives businesses like Nitin’s the ability to prepare for the next purchase, while saving taxes. The approach helps to manage money effectively as time goes on, channelling loss of assets into better financial results.

FAQs

1. What is depreciation?

Depreciation is the gradual loss in value of things you own, like cars or machines, because they get older or wear out over time.

2. Why does depreciation matter?

It helps businesses like Nitin’s show lower profits on paper, which means paying less tax. It also helps plan for replacing old assets without financial shocks.

3. How is depreciation calculated?

The simplest way (straight-line method) divides the asset’s cost minus its scrap value by its useful years. Nitin’s ₹10 lakh car with a ₹2 lakh scrap value over 10 years loses ₹80,000 yearly.

4. What’s the difference between straight-line and WDV methods?

Straight-line deducts equal amounts yearly (like Nitin’s ₹80,000), while WDV deducts more in early years (e.g., ₹2 lakh first year, then less each following year).

5. Can depreciation save me taxes?

Yes! By claiming depreciation, Nitin reduces his business’s taxable profit. Lower profit = lower tax, even though no actual cash is spent.

6. Do all assets depreciate?

No, only assets that lose value over time (cars, machines). Land or investments like stocks don’t depreciate.

7. What’s salvage value?

It’s what the asset is worth at the end of its life. Nitin’s car may sell for ₹2 lakh after 10 years, that’s its salvage value.

8. Can I change depreciation methods later?

Usually no. Tax rules require you to stick to one method for each asset unless there’s a special reason to change.

9. How does depreciation affect selling an asset?

If Nitin sells his car for more than its depreciated value, the extra profit is taxable. If sold for less, he can claim a loss.

10. Is depreciation the same as maintenance costs?

No. Depreciation is a paper loss in value, while maintenance (like repairs) is real cash spent to keep the asset working. Both reduce profits but differently.