What is Depreciation in Accounting?

Depreciation is an accounting method for allocating the cost of fixed assets over their useful lives . This reflects the fact that assets lose value over time and ensures correct cost allocation in the accounts .

What is Depreciation?

Depreciation is a non-cash expense that reduces the carrying amount of a fixed asset over time. The purpose is to:

• Allocate costs over the asset's economic life
• Reflect depreciation due to wear and tear and age
• Ensure correct performance measurement by matching costs with revenues
• Provide realistic valuation of assets on the balance sheet through balance sheet-based valuation

Basic Principles

Depreciation is based on the matching principle in accounting:

• Costs should be recorded in the same period as the related income.
• Fixed assets contribute to income generation over several years
• The acquisition cost must therefore be distributed over the useful life.
• Accumulated depreciation reduces the asset's carrying amount.

Depreciation methods

There are several methods for calculating depreciation, each with its own advantages and areas of application.

Linear Depreciation

Straight-line depreciation is the most commonly used method in Norway. It distributes the acquisition cost evenly over the asset's useful life.

Formula for Linear Depreciation:

 Årlig avskrivning = (Anskaffelseskost - Restverdi) ÷ Brukstid i år

Example: Straight Line Depreciation

A machine is purchased for 500,000 NOK with an expected useful life of 10 years and a residual value of 50,000 NOK .

Calculation: - Depreciation basis: 500,000 - 50,000 = NOK 450,000 - Annual depreciation: 450,000 ÷ 10 = NOK 45,000 per year - Depreciation rate: 45,000 ÷ 500,000 = 9% per year

Declining Depreciation (Balance Depreciation)

Declining balance depreciation results in higher depreciation in the early years and lower depreciation later on, reflecting the fact that many assets lose the most value early in their useful lives.

Formula for Declining Balance Depreciation:

Årlig avskrivning = Bokført verdi × Avskrivningssats

Example: Declining Balance Depreciation

Same machine with 25% depreciation rate :

Year	Book value (start)	Depreciation	Book value (end)
1	500,000	125,000	375,000
2	375,000	93,750	281,250
3	281,250	70,313	210,937
4	210,937	52,734	158,203
5	158,203	39,551	118,652

Selection of Depreciation Method

The choice between the methods depends on:

• Nature of the asset: Technology is often depreciated on a declining balance basis
• Usage pattern: Regular use favors straight-line depreciation
• Tax rules: Balance groups require declining balance depreciation
• Accounting standards: IFRS may require specific methods

Tax Depreciation

In Norway, tax depreciation is regulated by the Tax Act through a system of balance groups .

Important Balance Groups

Balance group	Assets	Maximum rate	Method
a	Buildings, hotels	4%	Balance
b	Office machines, EDB	30%	Balance
c	Machinery, equipment	20%	Balance
d	Cars, means of transport	25%	Balance
e	Ships, aircraft	14%	Balance
f	Pipelines	5%	Balance
g	Commercial building	6%	Balance
h	Goodwill	20%	Balance
in	Intellectual property rights	20%	Balance

Difference Between Accounting and Tax Depreciation

Accounting depreciation: - Based on actual usage time and economic life - Can use linear or degressive method - Should reflect real impairment

Tax depreciation: - Follows fixed rates in the tax law - Mainly balance depreciation - May differ from accounting depreciation

Accounting for Depreciation

Basic Accounting

Depreciation is recorded monthly or annually with the following vouchers:

 Debet: Avskrivningskostnad (kostnadskonto)
 Kredit: Akkumulerte avskrivninger (motkonto til anleggsmiddel)

Example: Monthly Depreciation

For the machine in the example above (NOK 45,000 annually): - Monthly depreciation: 45,000 ÷ 12 = 3,750 kr

Accounting every month:

 Debet: Avskrivningskostnad 3.750
 Kredit: Akkumulerte avskrivninger 3.750

Impact on the Financial Statements

Income statement

• Depreciation expense reduces operating profit
• The cost is tax deductible .
• Affects cash flow indirectly through taxes

Balance

• Fixed assets are shown at historical cost.
• Accumulated depreciation is deducted as a counter account
• Book value = Historical cost - Accumulated depreciation

Example: Balance sheet presentation

Fixed assets	Year 1	Year 2	Year 3
Machines (historical method)	500,000	500,000	500,000
Accumulated depreciation	(45,000)	(90,000)	(135,000)
Book value	455,000	410,000	365,000

Practical Examples

Example 1: Office furniture

A company purchases office furniture for 200,000 kr with an expected useful life of 8 years and a residual value of 20,000 kr .

Straight-line depreciation: - Depreciation basis: 200,000 - 20,000 = NOK 180,000 - Annual depreciation: 180,000 ÷ 8 = NOK 22,500 - Monthly depreciation: 22,500 ÷ 12 = 1,875 kr

Tax-wise (balance group c - 20%): - Year 1: 200,000 × 20% = NOK 40,000 - Year 2: 160,000 × 20% = NOK 32,000 - Year 3: 128,000 × 20% = NOK 25,600

Example 2: Company car

A company car is purchased for 400,000 NOK with an expected useful life of 5 years and a residual value of 100,000 NOK .

Accounting (linear): - Annual depreciation: (400,000 - 100,000) ÷ 5 = NOK 60,000

Tax-wise (balance group d - 25%): - Year 1: 400,000 × 25% = NOK 100,000 - Year 2: 300,000 × 25% = NOK 75,000 - Year 3: 225,000 × 25% = NOK 56,250

Temporary Differences

The difference between accounting and tax depreciation creates temporary differences that must be handled in the accounts:

• Deferred tax when tax depreciation > accounting depreciation
• Deferred tax asset when accounting depreciation > tax depreciation

Special Situations

Component depreciation

For large and complex fixed assets, component depreciation may be necessary:

• Buildings: Roof, facade, technical installations are depreciated separately
• Machines: Main components and spare parts with different service lives
• IT systems: Hardware and software are depreciated differently

Write-down vs. Depreciation

Depreciation is planned depreciation, while impairment is a decrease in value beyond normal depreciation:

• Depreciation: Systematic allocation over useful life
• Impairment: Sudden decrease in value (technological development, damage)
• Reversal: Impairment losses can be reversed, depreciation cannot

When assessing the need for impairment, the recoverable amount is often calculated by discounting future cash flows to present value.

Depreciation on Sale

When selling a fixed asset before the end of its useful life:

1. Calculate accumulated depreciation up to the date of sale
2. Book value = Cost - Accumulated depreciation
3. Gain/loss = Selling price - Book value

Example: - Machine purchased for 500,000 NOK, depreciated by 180,000 NOK - Book value: 320,000 NOK - Selling price: 350,000 kr - Profit: 350,000 - 320,000 = NOK 30,000

Depreciation and Cash Flow

Non-cash Cost

Depreciation is a non-cash expense :

• Reduces profit without directly affecting cash flow
• Tax effect: Reduces taxable income and thus tax
• Cash flow analysis: Added back to net income

Tax effect of Depreciation

Example of tax effect: - Depreciation: 100,000 NOK - Tax rate: 22% - Tax savings: 100,000 × 22% = NOK 22,000 - Net cash flow effect: 22,000 NOK (positive)

Digital Tools and Automation

Accounting systems

Modern accounting systems automate depreciation calculations:

• Automatic calculation based on predefined rules
• Monthly provisions for even cost distribution
• Reporting of both accounting and tax depreciation
• Tracking individual fixed assets

Fixed asset register

A good fixed asset register contains:

• Identification: Unique number, description, location
• Financial data: Acquisition cost, depreciation method, useful life
• Depreciation history: Accumulated depreciation, book value
• Maintenance: Costs, upgrades, repairs

Common Mistakes and Pitfalls

Typical Errors

• Forgetting depreciation: Leads to overvalued assets and incorrect results
• Incorrect usage period: Too short/long period results in incorrect cost distribution
• Mixing methods: Inconsistent use of linear vs. degressive
• Ignoring residual value: Significantly affects the depreciation basis

Best Practices

1. Establish clear guidelines for depreciation methods
2. Assess usage time realistically based on experience
3. Document the choice of methods and assumptions
4. Regularly review whether assumptions still apply
5. Difference between accounting and tax depreciation

Difference from Amortization

Many people confuse depreciation with amortization , but there are important differences:

Aspect	Depreciation	Amortization
Applicable	Tangible fixed assets	Intangible assets
Examples	Buildings, machines, cars	Goodwill, patents, software
Methods	Linear or degressive	Mainly linear
Visibility	Physical wear and tear observable	Impairment less visible

International Standards

IFRS vs. Norwegian GAAP

IFRS requirements: - Component depreciation mandatory for significant components - Annual assessment of useful life and residual value - Impairment tests when there are indications of impairment

Norwegian GAAP: - Simpler rules for small and medium-sized enterprises - Less detailed requirements for component depreciation - Practical approach to assessments

Related Concepts

To fully understand depreciation, you should also know:

• Fixed assets - The assets that are depreciated
• Acquisition cost - The basis for depreciation calculation
• Assets - How depreciation affects the balance sheet
• Amortization - Similar principle for intangible assets

Conclusion

Depreciation is a fundamental accounting principle that ensures the correct allocation of costs and realistic valuation of fixed assets. By understanding the different methods, tax rules and practical applications, businesses can:

• Optimize your tax position through the right depreciation strategy
• Improve the decision-making basis for investments
• Ensure correct accounting and reporting
• Avoid common mistakes that can affect results and balance

Correct handling of depreciation is essential to provide a true picture of the company's financial position and results.