Building depreciation is the loss of value over time due to factors such as deterioration. Straight-line depreciation is the most commonly used method, but reducing depreciation from building balances gives a better idea of the property’s true value. Underestimating asset value is generally best in business.
Depreciation can be defined as the amount that an asset or building loses in value over time due to unavoidable factors such as deterioration. Building depreciation can be calculated in a number of ways, including depreciation on a straight-line basis or by the depreciation method. Straight-line building depreciation is calculated by estimating the value of the property at the end of its useful life and using its current value to subtract a set percentage from its value each year. When using the balance reduction method, a higher initial depreciation charge may be preferred, but subsequent losses are reduced each year.
Straight-line building depreciation is most often used as it is the least confusing method of calculating loss in property value. It may not be completely accurate, but it gives company accountants a tangible figure to enter on the income statement that helps simplify annual accounts. It is not easy to determine how much a building will depreciate over a long period of time; each property is different, so the straight-line method may not be the best means of calculating the loss on such an asset.
Suppose a company has a building currently valued at $300,000 US dollars (USD) and decides that the salvage value after five years will be $150,000. You will subtract the final value from the current cost and divide it by the number of years of useful life. In this case, $300,000 – $150,000 / 5 = $30,000 annual depreciation. So, at the end of the first year, the building will be worth $300,000 – $30,000 = $270,000. In its final year, the building will start at a value of $180,000 and end at $150,000.
Reducing depreciation from building balances is more complex, but gives a better idea of a property’s true value. This is calculated by multiplying the depreciation rate by the current value of the property. The rate is usually determined by doubling the straight-line estimated percentage.
In the example above, the rate is 10% and the fixed value of the building is $300,000. Using the balance depreciation reduction, the rate would double to 20%. This means that the first year’s depreciation is 20% of $300,000 or $60,000, leaving the value of the building at the end of the first year at $240,000. Instead of using $300,000 as the figure for the second year, a starting value of $240,000 is used.
At the end of the second year, the building would be worth $192,000 or $240,000 x 20%. The value of the property at the end of year five would be $93,804. While this may not be as high as the building’s straight-line depreciation method, it does ensure that a business does not overvalue its assets. In the business world, it’s generally best to underestimate the value of assets to avoid unpleasant surprises later.
Smart Asset.
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