Depraciation

Assets such as machinery, equipment and buildings reduce in value as they are used over their working lives. This reduction is known as depreciation. In the construction industry, the calculation of depreciation of plants and machineries which are used for construction purposes is very important. Because large number of plants and machineries are used for construction.
Simple mathematical formulas are used for Calculation of depreciation of items. Depreciation is not an actual cash out when plants and machineries or other assets come to the end of its life and scrapped or sold. Depreciation will be high where machines and equipment are replaced often and it can be very variable.
To avoid assessing the value of each plant and machine or other equipment every year within a project to calculate its drop in value or depreciation, a standard method is used to reduce the value. Basically there are few common methods to calculate depreciation. They are straight-line method, reducing balance method and units of production method. In three of these methods, the calculation of depreciation starts with the initial cost of the asset. But each method produces different results. Here the expectation is to focus about the unit of production method.

1. STRAIGHT LINE DEPRECIATION METHOD
Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the residual value of the asset at the end of the period during which it will be used to generate revenues (useful life) and will expense a portion of original cost in equal increments over that period. The residual value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Residual value is also known as scrap value or salvage value.
Annual Depreciation Expense = (cost of fixed asset – residual value) X actual miles driven
Useful life of the asset (years)

2. REDUCING BALANCE METHOD
Under this method, the annual depreciation charge is higher in the first few years of the life of the asset and reduces gradually as the machine ages, thereby attempting to recognize the actual drop in value.
Instead of a fixed sum being taken as the annual reduction in value, a fixed percentage reduction is applied to the value of the asset, reducing the balance each year.
Annual Depreciation Expense = 1 – N residual value
Cost of fixed asset



3. UNITS OF PRODUCTION METHOD

Units of production method is based on an asset’s usage. (The assert may be a plant, machinery or a tool). Therefore the calculation of depreciation is based on some significant features of the plant, machinery or the equipment. They can be expressed in units produced, hours consumed or it would be miles driven. Under the units-of-production method, useful life of the asset is expressed in terms of the total number of units expected to be produced:
Units Produced Method
Under the first variation of the ”Unit Of Production“ method, a fixed amount of depreciation is allocated to each unit of output produced by the machine. The per-unit depreciation expense is multiplied by the number of units produced in each considered period. (e.g.:-1 year). This depreciation method accurately reflects the depreciation expense for the asset because it is based on the number of units produced in each period.
Annual Depreciation Expense= cost of fixed asset – residual value) X actual units produced
Estimated total number of units can produce
Hours Used Method
In the second variation of unit of production (the hours used method), a fixed amount of depreciation is allocated based on the number of hours the machine is used.
Annual Depreciation Expense = (cost of fixed asset – residual value) X actual hour used
Estimated total number of hours can use
Mileage Driven
Under the third variation (mileage driven) of unit of production depreciation, instead of using time to calculate depreciation, the number of miles driven are the “units”. This type is good for vehicles. Because most of the time the life of the vehicles can be measured by considering the number of miles that could be driven. Therefore if consider a truck, the expense per miles will remain constant over the life
Annual Depreciation Expense= (cost of fixed asset – residual value) X actual miles driven
Estimated total number of miles can drive



SELECTION OF SUITABLE METHOD TO CALCULATE THE DEPRECIATION

To calculate the depreciation accurately, selection of suitable depreciation method is very important. The best method of depreciation may vary when change the considered plant, equipment, machinery or other relevant factors.
When considering vehicles, plants and machineries the values of them reduce due to the usage and technology advancement. Therefore depreciation of them is depending on both the time factor and the unit factor. Therefore both the unit of production method or reducing balance method or combination of them can be used for calculation. But here unit of production method is better as the second market value of vehicles, machineries and plants highly depend on the how much it had been used.

• Vehicle: - how long it has already been run.
• Machinery: - how many items it has already been produced.

But to practice this method, is should be possible to measure the used units easily and accurately. When consider a new vehicle, the vehicle represent itself how long it has been run by the meter. But after few years, new vehicles with advanced technology come to the market. As a result, the value of that previous vehicle becomes less. In that case it is suitable to use the reducing value method to calculate the depreciation.
Therefore according to my view it is suitable if the units of production method is practiced for early few years and use the reducing balance method hereafter. But here the considered vehicle, plant or machinery should represent itself the usage of them in terms of measurable units.
But when consider the practical situation, it is not possible to measure the usage of plants and machineries in terms of units. Therefore it is better to use the reducing balance method from the beginning.