Depreciation is the eventual loss of value of an asset. For example, something you own, like a computer or a car, gets older and loses value over time. This can happen because of normal wear and tear or because new and better things are available. In accounting, depreciation determines how much an asset is worth over time and after its use. This helps businesses and people understand the value of their things and make decisions about buying new things. In our examples, we will use a vehicle.
There are different ways to calculate depreciation, and the basic idea is to take the cost and divide it by how many years it will last. This will tell us how much the value of the thing decreases yearly. Depreciation happens at different rates in the item’s useful life. For example, a car driven a lot will probably lose value faster than a car driven only a little.
Depreciation differs from losing money because you don’t have to pay anything. Instead, it’s a way of keeping track of how much the value of a thing changes over time. This helps us understand how much money a business or a person has, even if they don’t have to spend any cash.
Vehicles *on average* depreciate around 30% in the first year and lose 15% of their value each year, according to CarsDirect, and 10% according to KBB. Canadian BlackBook shows the average used vehicle depreciation rate in Canada. Current market conditions have caused used vehicle prices to increase in 2021, but in general, they predictably decrease.
If we take the average depreciation rate over the last decade before 2020, we have 12% on average. So, if we bought a used $7,500 car and sold it five years later, the value would look like this over time. At this rate, the vehicle’s value is about half the original value between years 5 and 6.
We can see how the line flattens over time if we plot it on a graph. This is due to the vehicle already depreciating to a lower value. This chart is extended to 10 years to make the curve more obvious. The numbers will be lower if you plan to sell your vehicle at an auction or to a dealership, which will usually pay wholesale prices.
It’s important to note that different things affect the rate of depreciation, like how much the vehicle is used, the condition, the expected useful life of the vehicle, location, and availability of comparable vehicles. The numbers used here are for educational purposes, and it is up to the buyer or seller to research the value of their vehicle. The Canadian BlackBook is a good resource for finding what similar vehicles have recently sold in addition to local listings in marketplaces like kijiji.ca, Autotrader, CarGurus, Carsguide.ca, and Drivewise.
If you want a more in-depth look at depreciation for businesses, there’s more at Investopedia.