Following are the three important factors which should be considered for determining the amount of depreciation to be charged to the profit and loss account in respect of a particular asset.
1. Cost of the asset
The cost of the asset includes the invoice price of the asset less any trade discount plus all costs essential to bring the asset to a useable condition.
For example, if plant and machinery has been purchased for $10,000 and $2,000 have been incurred as freight charges for bringing the machine to the factory and $3,000 as installation charges, the cost of the machine for the purpose of depreciation should be taken as $15,000, (i.e., $10,000 + $2,000 + $3,000). It should be noted that financial charges such as interest on money borrowed for the purchase of the asset should not be included in the cost of the asset.
2. Estimated scrap value
The term scrap value means the residual or the salvage value which is estimated to be realized on account of the sale of the asset at the end of its useful life. In determining the scrap value, the cost to be incurred in the disposal or removing of the asset should be deducted out of the total realizable value.
3. Estimated useful life
This is also termed the as economic life of the asset. This may be calculated in terms of years, months, hours, units of output or other operating measures such as kilometres in case of a taxi or a truck.