Depreciation

IAS 16 defines depreciation as ‘the systematic allocation of the depreciable amount of an asset over its useful life’. The depreciable amount equals the purchase cost of the asset less the salvage value or other amount like revaluation amount of the asset. Depreciation amounts to distributing the cost of assets to the income statement over the useful life of the asset.

Depreciation is a non-cash operating activity which is the result of qualitative wear and tear in the use of asset but it has been quantified by the use of accounting principles and assumptions in line with the enterprise’s own accounting policies.

Depreciation is computed using various methods. Popular methods include the straight-line method and accelerated depreciation methods.

Presentation in Financial Statement:

Income Statement: The asset cost less salvage value is spread over the useful life of the asset. The amount of depreciation needs to be calculated each year and is debited to Income Statement like any other operating expenses. All the fixed and variable expenses are shown in the income statement.

Balance Sheet: Depreciation reduces the value of assets over time. Depreciation cumulatively rises over time and hits the cost less salvage value in the final year of useful life. The Balance sheet balances assets with liabilities and capital.

Variable cost

The variable cost is closely associated with the number of units of production or services given. The variable cost increases and decreases with production volume.

That means if the production volume goes up, the variable cost will also rise while on the other hand, if the production volume goes down, the variable costs would also go down.

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Variable costs differ among industries. Hence, it’s not useful to compare the variable costs between metal companies and manufacturing companies as they are not comparable. However, variable costs can be easily compared among the same industry like a metal company with another metal company.

Fixed cost

Fixed costs are the level of costs that are not associated with level of production. Unlike the variable cost, a company’s fixed cost does not vary with the volume of production.

The fixed cost remains the same even if no goods or services are produced, and hence, these cannot be avoided. The higher the company has fixed costs, the higher would be the breakeven target the company needs to achieve. The fixed costs occur regularly and rarely change.

Depreciation is fixed cost

Depreciation is fixed cost as it incurs in the same amount per period throughout the useful life of asset. Depreciation cannot be considered a variable cost, since it does not vary with activity volume.  However, there is an exception.

However, there is a notable exception when the company employs units of production method to depreciate fixed assets. In this case, depreciation would be variable costs as it is closely linked with the number of units of production. The nature of this method is more consistent with variable cost. Take an example of

For example, invertor machine or power generators in factories can be used on the number of hours being used, so that depreciation expense will vary the number of products used. This can be easily done by maintaining the log.

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However, usage-based depreciation systems are not commonly used, so in most cases, depreciation cannot be considered a variable cost.

Depreciation is fixed cost and used to compute breakeven cost of the company.