It’s a fact of life that assets lose value over the years. We call that depreciation or amortisation (more on that in a minute), and they play a key role in budgeting. Indeed, depreciation and amortisation belong to the world of accounting… But they’re very useful in maintenance management too.
Today, we’ll look into the difference between amortisation and depreciation, straight line depreciation, salvage value, and how to apply them. Ready to step out of the maintenance shell?
What is depreciation?
If you own a car, it’s probably worth a lot less than when you first bought it. It’s not as good as new, and it surely wouldn’t resell for the same price. That’s called depreciation. Like cars, assets and pieces of equipment also decrease in value. Even intangible assets lose value as they become outdated or expire. But we call that amortisation instead.
Over time, fixed assets will accumulate wear and tear, which compromises performance and requires stronger maintenance. Calculating asset depreciation shows how quickly these assets devalue, and how investments spread out in the long term.
Please note that only capital expenditures depreciate. In other words, only assets and equipment the company plans to use for more than a year will lose value. This includes building renovations and maintenance, fleets, hardware and equipment, and technology systems. Expenses incurred in day to day operations (appropriately called ‘operating expenditure’) don’t depreciate. This includes smaller expenses like utility bills, rent, salaries, travel expenses, and monthly subscriptions.
What is the difference between amortisation and depreciation?
Both amortisation and depreciation refer to the loss of value over a lifecycle. However, they are not the same thing. Depreciation applies to tangible assets, such as equipment, fleets, or hardware, for example. These assets will always be worth something, even if they have to be dismantled for parts – it’s their salvage value. Also, most of the time, wear and tear will not happen at the same rate across their lifespan.
On the other hand, amortisation applies to intangible assets. This includes patents, copyrights, or software, for example. Once they run their course, that’s it. There’s no salvage value and you can’t resell them. But, until that time comes, they tend to devalue at a constant rate. Warning: do not mistake this for credit amortisation, which consists (roughly) of a payment plan. This is not the same thing!
What is straight line depreciation?
There are several models to calculate how assets depreciate over their lifespan. Here are the four types of depreciation formulas:
- straight line depreciation, which assumes a uniform rate of devaluation;
- units of production depreciation, which calculates depreciation based on usage;
- declining balance depreciation, an accelerated depreciation model that expects higher depreciation in the early years;
- sums of years digits depreciation, also an accelerated method to calculate asset depreciation over time.
A changing rate of depreciation is more faithful to progressive wear and tear. Straight line depreciation, with its uniform rate of devaluation, comes closer to amortisation. So why do we keep using it, you ask? Because it’s an easier, and more convenient way to calculate depreciation in the blink of an eye.
How to calculate straight line depreciation
The formula to calculate straight line depreciation is as follows:
- cost corresponds to the original investment (cost of the asset);
- salvage value is the market price for the asset at a given point. For example, how much money a company can get in return for a 10 year old lorry. Remember, even when assets are sold for parts, that’s treated as salvage value.
- useful life is the number of years the asset has operated or is expected to.
Imagine selling a computer that cost £2000 5 years ago. If you sell it for £300, depreciation will be the cost (2000) minus salvage value (300), divided by 5. This comes to 340 a year. In this example, you’re spending £340 a year to use that particular asset.
Some countries, including the US, apply straight line depreciation to calculate tax. In the UK, HRMC does not use depreciation but “capital allowance”, which also provides tax relief over a certain period. But then again, this is something you need to sort out with accounting.
Why should you use straight line depreciation in maintenance?
Why would you apply an accounting concept in maintenance? It’s a fair question. But, in a way, we’ve already given you the answer. This is a straightforward method to estimate an asset’s financial worth and project depreciation. So, when the time finally comes to decide whether to repair or replace an asset, you can make an informed decision. If the asset has a low depreciation or amortisation rate, it’s probably worth the repair.
Projections about depreciation may also be useful when you’re looking for new equipment and technology. When equipment depreciates slowly, it’s easier to find funding for larger investments.
At last, you might want to insert costs and depreciation data into your CMMS or Intelligent Maintenance Management Platform (IMMP). We’ve already mentioned that keeping the same identification number across all departments is advantageous. Tracking costs and depreciation will help accounting and management with budgeting, and hopefully reduce expenses. Remember, record keeping never depreciates!