Depreciation and amortisation

Depreciation is an accounting method used to allocate the cost of a long-lived asset across its useful life. When a business buys an asset that is expected to be used over several periods, for example buildings, machinery or vehicles, the whole cost cannot be expensed in the year the asset is bought. Instead the cost is spread across several years through depreciation. (For intangible assets the corresponding term in English is amortisation; Norwegian uses avskrivninger for both.)

An example

Say that you buy a computer at a cost of NOK 40 000, and choose to depreciate it over five years. This means that the NOK 40 000 outlay is spread evenly across those five years. Each year the purchase will reduce the profit by NOK 8 000. In total you get the same deduction, but spread evenly over five years instead of affecting the profit in one year only.

Types of depreciation

There are essentially two ways of depreciating: straight-line depreciation and reducing-balance depreciation (in Norwegian saldoavskrivning).

Straight-line depreciation

Straight-line depreciation is a method for spreading the loss in value of an asset evenly across its useful life. The method assumes that the loss in value occurs at a constant rate each year.

In order to calculate straight-line depreciation you need information about the acquisition cost, the expected useful life and an estimated residual value at the end of that life. Usually you subtract the estimated residual value from the acquisition cost in order to arrive at the total depreciation to be spread across the useful life.

The total depreciation is then divided equally across the number of years in the useful life. The annual depreciation charge is therefore constant, and is deducted from the asset's value each year. The value is thus reduced gradually, and at the end of the useful life the asset's carrying amount will equal the estimated residual value.

Straight-line depreciation is a simple and common method in financial reporting for reflecting the loss in value of an asset over time. It gives an even and predictable depreciation schedule, which makes it easier to plan for costs and replacement investments.

Reducing-balance depreciation

Reducing-balance depreciation is a method for calculating depreciation on an asset based on a percentage of the remaining carrying amount. Unlike straight-line depreciation, where the depreciation charge is constant across the useful life, the depreciation charge under reducing-balance depreciation is adjusted according to the asset's remaining value.

Under reducing-balance depreciation the depreciation for each financial year is calculated by multiplying the asset's remaining value by a fixed percentage, called the depreciation rate. The remaining value is the difference between the acquisition cost and the total depreciation already recorded.

The depreciation rate can vary depending on the type of asset and the tax rules in force, and is normally set by Skatteetaten, the Norwegian Tax Administration, or by the relevant accounting standards. Higher depreciation rates at the beginning of the asset's useful life give larger depreciation charges in the first years, and the charges are reduced as the asset's remaining value falls.

Reducing-balance depreciation makes it possible to reflect the asset's actual loss in value over time, since the depreciation charge is adjusted in line with the remaining value. The method is particularly suited to assets with a higher loss in value early in their life, or where technological developments lead to rapid obsolescence.

Reducing-balance depreciation is used primarily in a tax context, for calculating taxable income. Depreciation for accounting purposes can, however, also use the reducing-balance method in certain cases, depending on the accounting standards and the company's own choice.