Depreciation is a weird concept isn’t it?
It’s meant to decrease the value of something you own. Why? Well in most cases, when you own something, say a computer, over time:
1) Wear and tear occurs just from normal usage
2) The market for second-hand is different from buying a computer at retail
So that value of your computer shouldn’t be shown in your financial reports at the amount that your originally bought it at because your assets (what you own) should be shown at their realistic value and your computer’s realistic value is likely to be lower than what you bought it at.
That’s where depreciation comes in.
You ‘depreciate’, meaning reduce the value of your computer by an amount to show a new figure that would represent the ‘realistic’ value of your computer.
There are two types of depreciation: Straight Line and Diminishing Value
1st year: $100,000 x 50% = $50,000 depreciation. Therefore, the remaining value of the asset is $100,000 - $50,000 = $50,000
5th year: $6250 x 50% = $3125 depreciation…. and you get the drift…
Depreciation is used for both an accounting and tax reasons, that’s another reason why you’ve got to do it.
Next: What is Net Assets? An Illustrated Example