Depreciation of fixed assets

Depreciation of fixed assets
See also
Amortization of intangible assets Sum of years digits method Non-operating expense Real value Depreciation rate Development cost Depreciable cost Finished product Economic obsolescence

Depreciation (depreciation / amortization write-off) is the monetary equivalent of consumption of fixed and intangible assets caused by its physical consumption - resulting from exploitation and economic (moral) - resulting from technical progress related to the possibility of obtaining modern machines, more efficient, cheaper in use, allowing to obtain products of better quality. This impairment is transferred to the value of products produced using amortized fixed assets. Depreciation is a type of cost that does not constitute a monetary expense. These costs include deductions due to systematic and planned distribution of the initial value of both fixed assets and intangible assets (excluding goodwill). Depreciation is an objective expression of the expenditures incurred that are needed to produce goods and services.

Depreciation starts no earlier than after being accepted for use (according to the balance sheet law), in the month following the month of entry into the register (according to tax law), and the ending when the write-offs are equal to the initial value of a specific fixed asset or put into liquidation, shortage.

Depreciation primarily has the following functions:

• amortization
• the cost
• reinstatement
• revenue at

Depreciation characteristics

Depreciation is subject to

Fixed assets already owned by the enterprise, newly acquired in a given financial year and adopted from completed investments, intangible assets, investments in external fixed assets, e.g. used on the basis of a lease or ([Rental agreement], buildings, structures on another land), other assets that are not owned by the taxpayer but meet the conditions for considering them as fixed assets, with an expected period of use longer than one year, used for business purposes.

Depreciation is not applicable

Museum exhibits, works of art and other objects included in long-term investments and land not exploiting open-cast minerals. Fixed assets and intangible assets that have been withdrawn are intended for liquidation or sale.

Kinds (methods) of depreciation

Linear depreciation

This is one of the most commonly used methods in business practice. It is based on an even distribution of the value of a fixed asset (WNiP) over time, as a rule it is a calendar year. It assumes that the object being used consumes evenly throughout its lifetime - this causes that the depreciation rate is constant and results from the formula

$A_{r}={\frac {W_{p}-W_{r}}{O_{u}}}$

where:

Ar - annual depreciation rate

Wp - initial value of a fixed asset

Wr - residual value

Ou - predicted period of use expressed in years

Diminishing depreciation

According to this method, the economic usefulness of a non-current asset decreases as it is used, which translates into the fact that depreciation write-offs in the initial years of using a fixed asset are higher than in the subsequent years. This allows faster to include the greater part of the initial value of the facility in costs, which is usually beneficial for the company (but not always). When calculating the depreciation amount, the depreciation rate does not change, but the basis from which we count changes. We count it on the net value, i.e. minus the existing write-offs.

In the Polish legal system, a specific variation of this method applies, sometimes called the degressive-linear method. In this method, write-downs are made using the degressive method, but starting from the year in which the depreciation calculated in this way would be lower than the depreciation calculated using the straight-line method, the straight-line method is used,

Natural depreciation

It reflects the natural and physical consumption of a given fixed asset. It assumes that the object's consumption is the same for every unit of work (e.g. art, kilogram, hour, etc.), so the amount of depreciation depends on the amount of work done in a given period of time. We calculate it from the formula

$A_{r}={\frac {W_{p}-W_{r}*P_{w}}{P_{p}}}$

where:

Pw- work done in a given period

Pp- work planned over the entire period of use

other designations as above

Progressive cushioning

According to this method, the depreciation amount increases with the end of the service life. It results from the assumption that the "older" object, the more it requires more expenditure on repairs, repairs, etc., so the costs of its exploitation increase. This method is beneficial for companies that for the first few years, from the introduction of a fixed asset to the records, incur a loss.

Depreciation of the revenue margin

For example, the method of net income - in accordance with this method, the value of a non-current asset is amortized proportionally to the net profit margin achieved in particular periods.

$A_{r}={\frac {W_{p}-W_{r}*M_{p}}{P_{sz}}}$

where:

Mp - expected net revenue margin in a given period

Psz - estimated net revenues achieved using this facility

other designations as above

Inventory depreciation (estimated)

It consists in estimating the current value of a given object and by comparing this value with the value at the beginning of the period, the amount of depreciation for a given period is determined.

$A_{r}=W_{k}+\Delta W-W_{k}$

where:

ΔW - increase in value

W_k - value at the end of the period

other designations as above

The disadvantage of this method is high objectivity and the fact that the valuation is subject to a very strong change in prices on the market, which may lead to incorrect conclusions,

Group depreciation

In this method, a group of assets with similar utilization in the enterprise, a similar initial value and a similar period of economic usefulness are depreciated. This method usually applies to objects with a low unit value.

The most common methods are: linear, degressive and natural, while for objects with a low unit value also a group method. The other methods are definitely less important.

Regulations in Polish law

In the Polish legal system:

1. As regards the balance sheet law - there is no specific method imposed, only obligates to systematically and planned distribution of the initial value for a fixed depreciation period. When determining the depreciation period (rate), account should be taken of the economic useful life of the measure, which is affected in particular by the number of changes on which it is used, the pace of technical and economic progress, legal and other restrictions on the time of use, residual value, and efficiency. Only goodwill and costs of development works, included in intangible assets, are depreciated no longer than 5 years - goodwill in justified cases up to 20 years. In addition, funds with a low unit value can be amortized together or once,
2. Tax law allows:
   • Linear amortization - in determining the rates in the Depreciation Amortization Schedule, in justified cases, e.g. due to deteriorated conditions of use, these rates may be increased by appropriate coefficients,
   • damping-linear depreciation - discussed above,
   • you can individually set depreciation rates for used or improved fixed assets for the first time entered into the taxpayer's records, as well as for investment in foreign fixed assets accepted for use - only the minimum depreciation periods have been determined,
   • for brand new fixed assets, in the first tax year, in which these funds were entered into the records, 30% of the value can be written off,
   • taxpayers may not make depreciation write-offs on assets, whose initial value does not exceed PLN 3,500, expenses for their purchase are then the cost in the month of putting them into use.

References

• Bu, Y. (2006). Fixed capital stock depreciation in developing countries: Some evidence from firm level data. The Journal of Development Studies, 42(5), 881-901.
• Katz, A., & Herman, S. W. (1997). Improved estimates of fixed reproducible tangible wealth, 1929-95.
• Fraumeni, B. (1997). The measurement of depreciation in the US national income and product accounts. Survey of current business-United States Department of Commerce, 77, 7-23.