If you have a company which has equipment, such as cars, that equipment will be worth less and less over the years as it gets older – this is depreciation. There are a number of ways of treating how the equipment loses value.
This is where you treat the equipment as losing a fixed amount of value each year.
For instance, a car worth $20000 might lose $1000 value every year.
A plot of an item’s value versus time for this type of depreciation would be a straight line – hence the name.
This is where you treat the equipment as losing a fraction of its current worth every year. This means that the equipment loses value most quickly when it is new, and more slowly later in its life.
For instance a car worth $20000 might lose 10% of its current value every year:
· After one year it is worth $18000 – it lost 10% of $20000.
· After two years it is worth $16200 – it lost 10% of $18000.
· After three years it is worth $14580 and so on…
The formula for working out how much something is worth after a certain number of years by this method is:
· ‘A’ = its worth after ‘n’ rests
· ‘i’ is the fraction of its value it loses each time period
· ‘P’ is what it is worth at the start.
A lot of equipment can be sold as scrap even after it is no longer useful. The relevance of this is that a $20000 car, when it is finally retired, can still be sold as scrap for say $4000, which means that only $16000 is needed to replace it with a new car.