Depreciation doesn't measure what the asset is worth, and it sets aside no cash. It's the mechanical release of cost you've already spent into the P&L, across the periods the asset serves. It's the same logic that moves inventory into COGS, on a longer clock. A Mumbai office building can triple in market value while it's being depreciated to near zero, and both numbers are correct. Accounting answers "what did it cost and how much is used up?" They don't try to answer "what would it fetch?" Land isn't depreciated at all, because it doesn't get used up.
You need three inputs. First comes the depreciable base, which is cost − residual (salvage) value. Then there's the useful life, meaning the life to this owner, as opposed to physical life. Last is the pattern, or method. All three are estimates, and every one of them is a lever.
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Worked example: three methods on one machine
The three methods, one asset. A machine costs ₹12 crore, with salvage of ₹2 crore and a 5-year life. It's rated for 100,000 units of output, produced as 30,000 / 25,000 / 20,000 / 15,000 / 10,000 across years 1 to 5.
Straight-line (SL): (12 − 2)/5 = ₹2.0 crore per year. Equal service, equal charge.
Written-down value (WDV) / declining balance: a fixed rate on the opening book value. Salvage isn't subtracted from the base, but depreciation stops when it reaches salvage. Using double-declining, rate = 2/5 = 40%:
| Year | Opening BV | Charge @40% | Closing BV |
|---|---|---|---|
| 1 | 12.00 | 4.80 | 7.20 |
| 2 | 7.20 | 2.88 | 4.32 |
| 3 | 4.32 | 1.728 | 2.592 |
| 4 | 2.592 | 0.592 (floored at salvage) | 2.00 |
| 5 | 2.00 | 0 | 2.00 |
In year 4 the formula charge (40% × 2.592 = 1.037) would breach the ₹2 crore salvage floor, so it's cut to 0.592. India's Schedule II derives WDV rates from useful life with rate = 1 − (salvage/cost)^(1/life). For a 5-year life and a 5% residual, that gives 1 − 0.05^0.2 ≈ 45.1%.
Units of production (UoP): (12 − 2) ÷ 100,000 = ₹1,000 per unit, which gives charges of 3.0 / 2.5 / 2.0 / 1.5 / 1.0 crore. Here the expense tracks use, so it's the method of choice for mines, for aircraft engines by flying hours, and for moulds.
| ₹ crore | Y1 | Y2 | Y3 | Y4 | Y5 | Total |
|---|---|---|---|---|---|---|
| Straight-line | 2.00 | 2.00 | 2.00 | 2.00 | 2.00 | 10.00 |
| WDV (DDB 40%) | 4.80 | 2.88 | 1.728 | 0.592 | 0 | 10.00 |
| Units of production | 3.00 | 2.50 | 2.00 | 1.50 | 1.00 | 10.00 |
Same asset, same ₹10 crore of lifetime depreciation. Only the path differs. WDV front-loads the charge, which makes early profits conservative and flatters later ones. Your choice of method should mirror how the benefits are consumed. In practice SL dominates listed-company books in both markets because it's simple and smooth.
What happens when an estimate changes or an asset is sold?
Changes and disposals.
- A revision of useful life, salvage or method is a change in estimate. It applies prospectively only, with no restatement. New charge = (carrying value − revised salvage) ÷ revised remaining life. US GAAP calls a method change "a change in estimate effected by a change in principle", and it's still prospective. Every life extension announces itself in this note, so read it.
- Two sets of books, legitimately (India). Company-law books follow Schedule II lives. For tax, the Income-tax Act prescribes WDV on "blocks of assets", such as 15% for general plant and 40% for computers. That book-vs-tax gap creates deferred taxes. You'll build the machinery for them on the deferred tax page. For now, just see why the gap exists.
- Disposal. Derecognize the cost and the accumulated depreciation. Proceeds minus net book value is a gain or loss on sale in the P&L, often shown as "other income" in India. Proceeds go in CFI, and the gain is subtracted in indirect CFO so it isn't counted twice, the same loop you traced in the statement-linkage capstone. Say the cost was ₹12 crore, accumulated depreciation ₹9 crore, and you sell for ₹4.2 crore. That's a gain of ₹1.2 crore, booked as Dr Bank 4.2, Dr Acc. Dep. 9.0, Cr PP&E 12.0, Cr Gain 1.2. Recurring "one-off" disposal gains dressing up operating results are Phase 2 material.