Depreciable Cost: Formula, Example, Merits and Demerit?

What is the Depreciable Cost?

Depreciable costs are the total cost of an asset that can be depreciated over time. It’s a method used by businesses and individuals to determine the useful value of an asset.

Depreciable cost is the total depreciation that an asset has to bear over its useful life leaving the salvage value in the end. Depreciable cost can also be the sum of the accumulated depreciation of the asset for all its useful life.

How do you calculate the Depreciable Cost?

Direct Method

If you have the initial purchase price (which also includes the installation price) and the salvage value, then you can directly calculate the depreciable cost using the formula.

Indirect Method

If you do not yet have the salvage value but you have the rate of depreciation, then you can use any method of depreciation to calculate the annual depreciation of the asset and then add all those accumulated depreciation from the first year of the purchase till the last useful year to determine the depreciable cost.

Some of the most common depreciation methods are:

• Straight line method
• Declining balance method
• Units of production depreciation method
• Sum-of-the-year depreciation method

Formula of Depreciable Cost

Depreciable Cost Formula = Purchase Cost – Salvage Value 

where;

• Purchase Cost =  It refers to the total cost associated with buying service or an item , including the shipping cost, taxes, unforeseen expenses and other fees.

• Salvage Value = It refers to the estimated book value of the fixed asset at the end of its useful life.

Steps to Calculate the Depreciable Cost

Step 1: Determine the Asset’s Initial Cost

This will include the price of the asset along with all the costs associated with setting the service into use.

Step 2: Estimate the Salvage Value

This will include the amount the company expects to recover when the asset is sold or scrapped.

Step 3: Subtract the salvage value from the asset’s initial cost

Now, subtract the estimated salvage value from the cost of the asset to find the depreciable amount.

Example of Depreciable Cost

Happy Private Limited purchases machinery. The salvage value of the machinery is $5,000 and its useful life is 5 years. Its purchase price is $ 25,000.

Solution:

Given: 

• Purchase price of the asset = $ 25,000 
• Salvage value = $ 5,000
• Useful life of the asset = 5 years

Depreciable Cost = Purchase Cost – Salvage Value

                               = $ 25,000 – $ 5,000

                               = $ 20,000 

Merits of Depreciable Cost

• Making Well-Informed Decisions: Businesses can evaluate the profitability of different assets, compare them, and make more informed investment decisions.

• Planning for Budgeting: Businesses determine an asset’s current value and can decide whether it is suitable for the long run.

• Tax Regulations: It helps businesses reduce taxable income because the depreciable cost can be expensed over several years, resulting in tax savings.

Demerits of Depreciable Cost

• Complex calculation: Calculating the depreciable cost becomes complex if the salvage value or useful life of the asset is uncertain.

• Does not show market value: The depreciable cost does not necessarily show the market value. It could be possible that the book value is zero, but the asset still has a market value.

• Misleading Financial Statement: If the depreciable cost is inaccurate, then it will impact the depreciation expenses, leading to an effect on the financial record.

Conclusion

Depreciable cost is a crucial concept for businesses as it allows accurate allocation of an asset’s cost over its useful life, expenses, and revenue generation. Businesses need to exercise caution in their judgments related to an asset’s useful life, salvage value, and depreciation method, as these decisions will have an impact on the company’s financial records.