Written Down Value Method of Depreciation

Hey! Have you ever realized that the smartphone you kept in your pocket is not worth as same as you purchased? Why does this happen? Have you ever thought about why a second-hand smartphone costs less than the new one?

Well, the majority of us thought that it happens because we have a vast variety of options available in the market when it comes to purchasing a smartphone, or no one wants to keep the same smartphone for a long time, but these are not the only reasons. Depreciation is something that is highly responsible for this. But before we dive deeper into it, let’s understand what depreciation is.

Depreciation is simply an accounting method used to find the cost of tangible assets over its life expectancy; it tells us how much it has been utilized and is worth now.

It’s easy, right!

Methods of calculating depreciation

Commonly there are two methods for calculating depreciation

• Straight-line method 
• Written down value method

Straight-line Method (SLM)

This method is as straightforward as its name; the value of an asset’s useful life depreciates with an equal amount every year.

Let’s understand how SLM works. 

Rate of depreciation = (100 - % resale value with respect to purchase price)/ useful life (in years)

Depreciation value (per year) = (Purchase price - Salvage value)/ useful life (in years)

Or

(rate of depreciation) * (purchase cost)

We’ll see the example of how the straight-line method works while comparing it with the written down value method of depreciation.

Also read, What is the Asset-Light Business Model?

Written Down Value Method (WDV)

If we take the example of your smartphone, you can realize that the cost of your smartphone depreciates drastically in the initial months of your purchase. The reason behind this is the WDV method of depreciation. This method is very practical & commonly used in real life.

Now, you must be thinking why it is so common? What makes it practical in real life? Don’t worry; the upcoming words will help you to understand how it actually works. In this method, depreciation is calculated over book value & the book value decreases every year.

Let’s understand its formula & how it works.

Depreciation rate = {1 - (s/c)^1/n} x 100

Here,

s = salvage value at the end of useful life of asset

c = cost (initial value) of asset

n = remaining useful life of asset

Err… Too complicated!!! Don’t worry; it’s easy to understand :)

Let’s take the example of your smartphone to understand this.

Purchase cost of your smartphone = Rs. 12,000 (just an assumption) :)

Salvage (resale) Value = Rs. 2,000

Useful life = 5 years

Depreciation rate (as per SLM) = (100 - 16.67)/5 = 16.67%

Depreciation value (as per SLM) = 16.67% x 12,000 = Rs. 2,000

Depreciation rate (as per WDV) = {1 - (2,000/12,000)^⅕} x 100 = 30.117%

From the above example,

If we talk about depreciation per SLM, you can see the depreciation value is the same every year.

But in the case of depreciation as per WDV, the depreciation value is high in the initial years of purchase but gets reduced as we come near the end of useful life.

So, you just understood the core difference between these two methods of depreciation! :) Easy, wasn’t it?

Well, you can also feel that the WDV method of depreciation is more practical and logical in real life, which is why it is widely used to evaluate the value of assets. In fact, the WDV method is only considered under the income tax act to calculate the depreciation of assets in companies.

Advantages of Written Down Value Method

• This method is easy to understand and can be applied to evaluate the depreciation value of assets based on their life expectancy.

• The amount of depreciation is higher in the initial years when the asset is new and its maintenance cost is low. Whereas, as the asset gets older, the depreciation gets lower as the asset requires high maintenance cost.

(This is the best advantage of the WDV method, which helps to balance the depreciation value of assets & helps companies to evaluate the actual book value of their assets)

• This method is recognized by the Income Tax Act and is allowed to calculate the book value of assets.

Disadvantages of Written Down Value Method

• The netbook value of assets never reaches zero under this method.

• The WDV method of depreciation is not applicable for assets having a short life span.

Conclusion

As you have seen both the methods of evaluating depreciation and how they actually work, we can conclude that the Written Down Method of depreciation is beneficial for finding the book value of costly assets and having a long life span. Companies use this method as it is recognized under the Income Tax Act.

On the other hand, the beauty of this method is that it is very practical & logical in nature. Also, it keeps the balance between the depreciation cost and the maintenance cost of an asset.

Hope this blog was helpful for you to learn about the Written Down Value method of depreciation.

Do let us know in the comment section if you have any questions regarding this topic and share this blog with your friends if they want to learn about the written down value method of depreciation.

Keep learning :)

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