This article mentions the three important factors to consider when determining the amount of depreciation to be charged to the profit and loss account in respect of a particular asset.
1. Cost of the Asset
The cost of the asset includes the invoice price of the asset less any trade discount, in addition to all costs that were essential to bring the asset to a useable condition.
For example, if a machine is purchased for $10,000 with $2,000 in freight charges and $3,000 in installation charges, the cost of the machine for the purpose of depreciation should be taken as $15,000, (i.e., $10,000 + $2,000 + $3,000).
It should be noted that financial charges such as interest on money borrowed for the purchase of the asset should not be included in the cost of the asset.
2. Estimated Scrap Value
Scrap value is the residual or salvage value that is expected to be realized after the sale of an asset at the end of its useful life.
In determining the scrap value, the cost to be incurred in the disposal or removal of the asset should be deducted from the total realizable value.
3. Estimated Useful Life
Estimated useful life is also known as the economic life of the asset. It can be calculated in terms of years, months, hours, units of output, or other operating measures (e.g., kilometers in the case of a taxi or truck).