WRITTEN DOWN VALUE VS. HISTORICAL COST: MAKING SENSE OF ASSET DEPRECIATION
When it comes to accounting for asset depreciation, two primary methods are often employed: Written Down Value (WDV) and Historical Cost. Understanding the differences between these approaches is crucial for businesses to make informed financial decisions and comply with regulatory standards.
Written Down Value (WDV)
The Written Down Value method involves depreciating assets based on their current value rather than their original purchase cost. This approach recognizes that assets lose value over time due to wear and tear, obsolescence, or other factors. Each year, the asset’s value is reduced by a certain percentage, typically determined by the Income Tax Act or Accounting Standards.
Key Points:
- Reflects Current Value: WDV considers the current market value of assets, providing a more accurate representation of their worth on the balance sheet.
- Accelerated Depreciation: Assets depreciate faster initially and slow down over time under the WDV method. This front-loaded depreciation can result in significant tax benefits for businesses in the early years of asset use.
- Frequent Revaluation: Assets under WDV need to be regularly revalued to reflect their current worth accurately. This process involves reassessing the asset’s condition, market demand, and technological advancements.
- Commonly Used in Taxation: The Indian Income Tax Act allows businesses to claim depreciation expenses using the WDV method, making it a popular choice for tax purposes.
Historical Cost
Contrary to WDV, the Historical Cost method records assets on the balance sheet at their original purchase price. Depreciation is calculated based on this cost, with the asset’s value gradually reduced over its useful life.
Key Points:
- Simple and Stable: Historical Cost provides a straightforward method of accounting for assets, as it relies on the initial purchase price without the need for frequent revaluations.
- Conservative Approach: Assets are recorded at their original cost, which can result in a more conservative financial statement, especially when market values have increased over time.
- Compliance with Accounting Standards: While WDV is often used for tax purposes, some accounting standards may require businesses to report assets at their historical cost for financial reporting.
- Less Reflective of True Value: Critics argue that the Historical Cost method may not accurately reflect the current value of assets, especially in volatile markets or industries with rapid technological advancements.
Both the Written Down Value and Historical Cost methods offer distinct advantages and considerations for businesses in India. While WDV provides a more dynamic reflection of asset values and offers tax benefits, Historical Cost offers simplicity and stability in financial reporting. Ultimately, the choice between these methods depends on factors such as industry norms, regulatory requirements, and the specific needs of the business. By understanding the differences between these approaches, businesses can make informed decisions regarding asset depreciation and financial management.
