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## What is Depreciation

Depreciation (depn) is used to measure the decrease in the useful life of an asset over a period of dollars. Measurement is an estimate because an asset may last longer than the estimated useful life or vice versa. Its purpose is to help a business reflect the cost of using the asset (excluding maintenance costs) during the asset’s useful life. Without this measure, a business would have lower profits or even a loss for the period in which the asset is acquired and reflect higher profits in subsequent periods while the asset is still being used for the business.

Accumulated depreciation is the total decrease in the value of the asset after the asset is purchased. You have an asset that you purchased for $9,000 and it is estimated to have a useful life of 3 years. Two years have passed. The accumulated dip is therefore two-thirds of the purchase price, or $6,000. Using this, you will be able to calculate the book value or residual value of the asset. Continuing from our example, the book value would be $3,000 because the asset has an estimated useful life of one year.

After 3 years, you can continue to use the property at “zero cost”. You can continue to use the asset and your net profit (which is the amount after deducting cost of goods and operating cost) would have increased by the amount of depn. Although this is not ideal, we are better off recognizing the full cost of the purchase in one year.

The most common method of depn is straight-line. An estimate is first made on the useful life of the asset. The value of the asset is then divided equally (usually by months) over the useful life of the project and that will be the depn value. For most assets, there are already statutory standards or recommendations on their useful life. Many businesses simply adopt these statutory standards. For example, it is a general rule of thumb to depreciate computers and computer peripherals over a period of 3 years. Other methods of depn include sum of year digits and double declining balance. The depn method to adopt for a particular asset is usually determined by how its value changes over time.

Depreciation can be a major contributor to a company’s profit and loss, especially for businesses that require heavy capital investment. For example, in a telecommunication company (telco), a telecom requires a large investment in its telecommunication network before it can offer its services to customers. Once invested in this network, the telco can use it for years in its services. It is therefore important for the telco to depreciate this cost over its useful life so that the company can reflect the true cost of providing the service to its customers. In this case, when setting up a business model for a telco business analyst, it is important to ensure that depn is calculated correctly or it can completely distort the profitability of the business.

Calculating depn in an Excel based business model is relatively easy if you have a good understanding of Excel worksheet functions. Instead of using a 36 column by 36 row table to calculate depn for an asset with a useful life of 3 years, you need to use a few formulas and only one row to calculate depn. Click on this depreciation link to find out how!

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