Appreciating Depreciation

Mar 10, 2007 by

Imagine that you bought a computer in 2005 for $2,000, and then sold it 24 months later, in 2007, for $1,300. Did you lose money? It depends on how you account for depreciation.

 What is depreciation?

Assets come in two varieties; those that appreciate (are worth more over time) and those that depreciate (are worth less over time). A rare Ferarri probably appreciates over time, and might be considered an investment for a car collector. A common Toyota Camry depeciates over time; by the time you sell it, it will be worth far less than its original purchase price. To depreciate means to lose value over time. When companies account for the value of their assets, they can choose to depreciate them using any method, so long as the method is clearly specified. The method of depreciation chosen will determine the accounting value of the asset.

Methods for Depreciating Assets

It is legitimate to use any means to depreciate your assets when performing accounting, so long as you are clear about which method you choose. Individuals not running businesses do not need to officially depreciate their assets, but can choose to do so as a means of mental accounting. The method of depreciation chosen can affect how one frames a transaction. The choice of depreciation method matters to companies, as it can affect their tax liability.

No Depreciation

If I wished, I could state that my computer did not depreciate. While blatantly untrue, if I did this, I would have to assume that a computer purchased in 2005 for $2,000 was still worth $2,000 in 2007. If I had purchased a $2,000 bar of gold in 2005 instead of a computer, this might be a more accurate assumption.

Straight-Line Depreciation

When using straight-line depreciation, you first determine how long it will take for the asset to be worth nothing. Then, you divide the initial value of the asset by that number to get the amount that the asset depreciates each year. For instance, if I thought the computer would be worth nothing in five years, I would calculate $2,000 / 5 = $400, and state that the computer depreciates by $400 per year. Thus, in 2007, the depreciated value of the computer is $2,000 – $400 – $400 = $1200.

 Non-Linear Depreciation

It is also possible to define a non-linear rate of depreciation. Non-linear depreciation may be appropriate for assets like commodity cars, which depreciate substantially the moment they are driven off of the lot, and then depreciate more slowly for the rest of their lives. Here’s an example of a non-linear rule for depreciation: The value of a computer halves every year. Using this rule, a computer purchased for $2,000 is worth $1,000 in 2006 and $500 in 2007.

So, did I get a good deal when I sold my computer?

To answer the question of whether I got a good deal when I sold my computer, I must first decide which method of depreciation I wish to use.

No Depreciation: $1,300 – $2,000 = -$700

Straight-Line Depreciation (5 year life): $1,300 – $1,200 = $100

Non-Linear Depreciation (value halves each year): $1,300 – $500 = $800

Thus, depending on my choice of depreciation method, I either got a great deal from the sale, or got a really bad deal.

On a side-note, I personally straight-line depreciate laptops over 36 months and straight-line depreciate desktops over 60 months.

4 Comments

  1. It seems to me that straight-line depreciating a computer is a little inaccurate. It seems that there is a steeper drop in a computer’s value near the end of it’s 5 years than at the beginning. Unlike a new car that has a premium for not having a previous owner, you can wipe a computer two months later and do a clean install and resell it to someone else for nearly the same price.

  2. I’m curious about your side note regarding depreciating laptops on a different schedule than desktop computers. I have not done any side-by-side comparisons lately (or computer purchases for that matter), but are laptops still only, say, 80% of the machine that most current desktops are? Or are you basing this deprecation schedule on people likely updating laptops on a more frequent basis due to the limited expandability most laptops suffer from?

  3. It’s a personal practice based upon laptops being less expandable, generally less powerful, and more subject to wear-and-tear. Also, a laptop’s battery usually becomes worthless in 18-24 months. When the battery is approaching the end of its life, and costs a substantial portion of the cost of a new cost of a laptop to replace, it often makes sense to sell. (I’ve seen batteries range from $100 – $350, depending on the type of laptop.)

  4. Nice Blog! I will definitley be a frequent visitor! I have a blog but yours have very good info. that the average person could use often! Great layout as well. I don’t think my computer is worth very much anyways since I’ve already had it about a whole year! :)

    Refered to by MTurk.com

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