Depreciation - A decrease or loss in value of an asset

Life of an asset affected by:

• Amount of ‘wear and tear’ of an asset
• Whether or not the product or machine becomes technologically obsolete
• Demand for the product or machine

Residual Value - The value of an asset at the end of its useful life.

Historic Cost - The initial cost of the asset

Straight-line method - where an equal amount is taken off the value of the asset on a yearly basis.

Advantages:

• The amount of depreciation is lower in the first few years
• Because less is deducted from deprecation makes the profit of that asset seem higher.

Disadvantages:

• An estimate of the residual value is required which for many assets is difficult to gauge
• It assumes that the life of the assets is known which may not be the case
• Having a lower amount of depreciation can be misleading

Reducing balance method - Applying the percentage rate of depreciation to each year.

Advantages:

• This method reflects deprecation a lot more realistically
• No estimate of the residual value is required

Disadvantages:

• With a higher level of depreciation the value could be a lot lower in the early years
• Lower valuation may make it harder to borrow against assets