The power generator that you purchase today for say, P 100 thousand, will not be worth the same price five years from now. It would have depreciated by then. In fact, every year, it loses some of its worth until it reaches the end of its lifespan, by which time it would be worth very little, maybe as little as few thousand pesos.
Yes, every machine has its time limit. It eventually becomes worn out or obsolete.
The percentage of the machine that is worn out each year is known as depreciation or yearly depreciation.
As owner-manager, you have to calculate the depreciation costs of your machines for the following reasons: (1) to actually determine imputed cost of production for the purpose of costing and pricing and (2) to include the cost of depreciation in operating expenses for tax purposes.
Calculating how much a piece of equipment has depreciated over a duration of one year or its entire life is quite simple. You can do it yourself with bits of information about the machine that should be at your fingertips.
- Determine the cost of acquisition of the machine. This figure can be determined by adding the original purchase price, transportation costs, sales tax, commissions, title fees, installation fees and other fees together.
- Determine the estimated life of the machine. This is the number of years that you expect the machine to last or the amount of output you expect from the machine in hours, miles or units produced.
- Determine the machine’s residual value. This is an estimate of the dollar amount that the machine will sell for at the end of its operational lifespan.
- Subtract the residual value of the machine from the previous step from the acquisition cost of the machine that you calculated in the first step to calculate the depreciable base. The depreciable base is the full amount that the machine can depreciate over the course of its life.
- Divide depreciable base by the number of years in the expected lifespan of the machine to calculate each year’s depreciation.
- Multiply the yearly depreciation value that you calculated in the previous step by the number of years the machine has been used. This will give you the total depreciation on the machine to date.
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