Component Depreciation and Group Depreciation
Component Depreciation is the process of separate one big asset into multiple components and depreciates them separately. For large fixed assets, each component may have a different useful life, scrap value and cost. So it is necessary to depreciate them separately.
Each component will be depreciated base on its own cost, useful life, and even the scrap value. We treat each component as an individual tangible asset. We need to separate the cost of each component since the purchased date. Management needs to estimate the useful life of each component base on previous experience and technical expert.
After getting component cost, useful life, and scrape value, they will be separated as individual asset and calculate the depreciation expense.
Company purchase huge machinery for the production department cost $ 5 million and it expects to use up to 10 years. The machine consists of three main parts, the head, tail, and body. The head and tail need to replace every two and four years respectively. Management has estimate the cost of the head is $ 1 million and the tail is $ 500,000. So they decide to depreciate three components separately.
The depreciation will be calculated as the following by using straight-line method:
- The head cost $ 1 million with 2 years useful life
Depreciation Expense = $ 1,000,000 / 2 years = $ 500,000 per year
- The tail cost $ 500,000 with 4 years useful life
Depreciation Expense = $ 500,000 / 4 years = $ 125,000 per year
- The body cost $ 3.5 million with 10 years useful life
Depreciation Expense = $ 3,500,000 / 10 years = $ 350,000 per year
Advantage of Component Depreciation
|This method will allow us to calculate the most accurate depreciation of each component. Each component may not have the same useful life, some may be reaching the end before one another. When we depreciate each component independently, we will be able to allocate the expense base on the nature of each one.
|When we need to replace one component, we just go straight to the item and replace it. It will not impact the whole assets.
|When one component is broken and requires replacement, we simply replace it as normal. It will not affect the other component or even the whole asset.
Disadvantage of Component Depreciation
|It requires further work from the management to allocate the cost of the whole asset to small components. It also requires allocating other costs that bring assets to use such as customs duty, transportation, and installation cost.
|Not for small asset
|It will not make sense to break down the asset even it is doable. For example, this method cannot apply to the computer to separate the mouse, keyboard, and monitor.
|There will be room for error to allocate fixed asset costs to each component and estimate the individual useful life.
Opposite from component depreciation, the group depreciation combined multiple assets and calculate depreciation expense as one item. When a company purchases multiple units of the same/similar assets on the same date, and they decide to combine them as one unit to calculate depreciation expense.
The depreciation expense base on the cost and useful life of all assets. The cost equal to the total cost of all assets and the useful life is the average of all assets.
Group depreciation uses when it is not necessary to trace each individual asset due to its low value. We will not be able to track down each individual asset.
Company XYZ purchases drill motor 100 units at $ 100 per unit. Each unit expects to use for up to four years. The company wants to do group depreciation as it is not necessary to track down each individual unit.
Depreciation Expense = (100 units x $ 100)/4 year = $ 2,500 per year
The company will treat this group of assets as an item. Even one or two of them broken or lost before the end of useful life, it will not impact the whole group. They will not record any write off if a few of them broken. However, they may decide to write off all of them when most of the items are broken due to any event.
Advantages of Group Depreciation
|It easy to treat a group of assets as one. We only do depreciation on a single item.
|The main purpose of group depreciation is to allocate the expense base on the best estimate without any difficulty.
Disadvantages of Group Depreciation
|Not able to track individual asset
|We will treat all assets in the group as one item, so we cannot track the individual asset. It is impossible to calculate gain/loss on each asset.
|For a group of small assets
|It only works for a group of small assets which is hard to control individually.