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11.2. Estimating Valuation

A central issue with depreciation is to determine how you will estimate the future value of the asset. Compared to the often uncertain estimates one has to do where appreciation of assets is concerned, we are on somewhat firmer ground here. Using sources listed below should make it fairly straight forward to estimate the future value of your depreciating assets.

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      Tax Codes: For businesses that want to use depreciation for tax purposes, governments tend to set up precise rules as to how you are required to calculate depreciation. Consult your local tax codes, which should explicitly state how to estimate depreciation.
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      Car Blue Book: For automobiles, it is easy to look up in references such as "Blue Books" estimates of what an automobile should be worth after some period of time in the future. From this you will be able to develop a model of the depreciation. 

11.2.1. Depreciation Schemes

A depreciation scheme is a mathematical model of how an asset will lose value over time. For every asset which undergoes depreciation, you will need to decide on a depreciation scheme. Since depreciation of assets is very often driven by tax policies, the discussion of depreciation will focus in that direction, on some of the more common depreciation calculation schemes.

Once you have an idea of the future value of your asset, you must decide on a depreciation scheme (remember, this may be dictated by your local tax codes). This section will present 3 of the more popular depreciation schemes: linear, geometric, and sum of digits. 

New text:

11.2 Depreciation Schemes
A depreciation scheme is a mathematical model of how an asset will be expensed over time. For every asset which undergoes depreciation, you will need to decide on a depreciation scheme. An important point to keep in mind is that, for tax purposes, you will need to depreciate your assets at a certain rate.  This is called tax depreciation.  For financial statement purposes you are free to choose whatever method you want.  This is book depreciation.   Most small businesses use the same rate for tax and book depreciation.  This way there is less of a difference between your net income on the financial statements and your taxable income.

This section will present 3 of the more popular depreciation schemes: linear, geometric, and sum of digits.  To simplify the examples, we will assume the salvage value of the asset being depreciated is zero.  If you choose to use a salvage value, you would stop depreciating the asset once the net book value equals the salvage value.