What’s the difference between appreciation and depreciation?

Every asset you possess will either appreciate or depreciate over time. In a nutshell, appreciation occurs when your asset gains value of any kind. Conversely, depreciation refers to the decrease in value, which can impact your financial stability. By being aware of how different assets behave over time, you can make more informed decisions that align with your financial goals and cultivate a money mindset focused on long-term growth and sustainability.

What is appreciation in accounting?

Appreciation is the rise in value of an asset based on different factors in the market. The most common assets that appreciate over time are assets that can be liquified into cash, such as currencies, bonds, real estate, or stocks. Asset appreciation can also be intangible, such as increased the company’s trademark value because of brand recognition.

Moreover, appreciation refers to the adjustment of the initial value of an asset as it is logged in a company’s account book. So, when an asset appreciates, it earns more than what you acquired it for, which means a high return on the asset is possible.

Appreciation can be:

• An asset having a new value which is more than its depreciable cost;
• An increase in the value of an asset due to the current market or economic climate or;
• An increase in the asset’s value is not due to developing or building on the asset.

Appreciation can be caused by several factors, such as:

• An increase in demand for your asset
• A decrease in supply of your asset
• Inflation
• Adjustments in interest rate

Appreciation rate formula

Before you can begin computing the appreciation rate of your property, you need to know the asset's initial value and current value. You need to see the amount of time it was appreciating or the holding period. Understanding this appreciation is particularly important if you're considering a home equity loan, as lenders often evaluate your property's increased value to determine how much you can borrow against your home equity.

To compute for the appreciate rate of an asset:

1. Divide the current value of your asset by its initial value
2. From there, you take the result and raise it by 1/(number of holding periods)
3. Then, subtract one from the answer

Sample computation for appreciation rate

Let’s say you purchase a home for your personal use:

• Initial cost of the car: PHP 10,000,000
• Current value: PHP 12,500,000
• Quotient: 0.25 or 25%
• Holding period: 5 years
• Appreciation: 25%
• Appreciation rate: (PHP12,500,000 / PHP 10,000,000)1/5 – 1 = 4.56% per year

Estimating an investment’s possible appreciation is key in picking the right investments.

What is depreciation in accounting?

Depreciation happens when an asset decreases in value. Its main basis is the decrease in value of a tangible asset over its useful life (or how long you can use it). Depreciation can also be considered as how much of your asset’s value has been used.

Depreciation can be seen in two ways:

• A decrease in asset value over time
• A decrease in asset value due to extended use (caused by factors like wear and tear)

Understanding depreciation and how to compute it helps you spread the cost of an asset of its useful life. With this, companies can properly predict how much revenue they can make from an asset and decipher how much it will cost them. It also allows you to adjust your cash flow and operational profits in your accounting books.

Not knowing how much your asset depreciates can affect your revenue (or net worth) because you may fall into the trap of purchasing an asset, which ends up costing you more than the revenue (or value) it brings in.

Yearly depreciation formula

Tangible assets are the ones most susceptible to depreciation.

The basic elements to compute for depreciation are as follows:

1. Start with the initial cost of the asset.
2. Find the expected residual value (also called the salvage value). This is the value of the asset at the end of its useful life. Some assets may have value, some end at zero.
3. The estimated useful life of the asset.
4. The appropriate method to decipher the cost of the useful life of the asset.

Keep in mind that there are no hard rules for when assets depreciate. In fact, not all tangible assets depreciate. For instance, stock and inventory will be used up in their entirety before they even have the chance to depreciate. If you need a guide, here is a good starting point:

• Plant and machinery - expense around 15% to 20% of the overall value a year. Useful life is typically between 5 to 7 years.
• Fixtures and fittings - expense around 15% of the overall value a year. Useful life is typically between 6 to 7 years.
• Furniture - expense around 20% of the overall value a year. Useful life is typically 5 years.
• Motor vehicles - expense around 25% of the overall value a year. Useful life is typically 4 years.
• Equipment (including computers) - expense around 33% of the overall value a year. Useful life is typically over 3 years.

Sample computation for depreciation

Let’s say you’re deciding between purchasing a brand-new vs used car. If you purchase a new car for your personal use, the depreciation computation would be as follows:

• Initial cost of the car: PHP 1,400,000
• Expected salvage value: PHP 300,000
• Difference: PHP 1,100,000
• Useful life of car: 4 years
• Depreciation rate: 25% a year
• Amount to depreciate: PHP 1,100,000 / 4 = PHP 275,000 a year

Suppose you choose to purchase a used car through a bank loan. In that case, the depreciation computation will differ based on the initial cost, expected salvage value, and useful life of the vehicle. Here’s how you might calculate it:

• Initial cost of the used car: PHP 800,000 (for example)
• Expected salvage value: PHP 200,000
• Difference: PHP 600,000
• Useful life of the car: 3 years
• Depreciation rate: 25% a year
• Amount to depreciate = (PHP 800,000 - PHP 200,000) / 3 = PHP 200,000 per year

Choosing between a new and a used car, for instance, involves considering not only the initial purchase price but also how depreciation affects overall ownership costs. A new car typically depreciates faster in absolute terms but may offer more reliability and features. A used car can be more economical upfront and may have lower annual depreciation costs, making it an appealing option for budget-conscious buyers.

The same can be said for any other type of tangible investment.

Depreciation vs. appreciation: Why they matter

Understanding the difference between appreciation vs. depreciation, and knowing how to adjust for them, are vital when owning a business or computing for your net worth. When you understand the basic theories of appreciation and depreciation, you will know which of your assets will appreciate or depreciate over time, which ones may never depreciate, and which assets you need to own for only a fixed period of time to avoid losing money.

Make the right investment decisions by talking to us at Metrobank today.