Depreciation in Equity Management – 35738

Document: Depreciation in Equity Management

The concept of Asset Depreciation

A depreciation consists of the natural loss of the value of the assets. This devaluation occurs due to the natural wear and tear of these assets, wear and tear caused by nature, or by the use of these assets in the production process. This concept affects Equity Management because the more depreciated an asset is, the less tax is paid on it. The depreciation is interesting for the management of a company because as the asset depreciates, the company pays less tax on it and accumulates capital that can be used to purchase a new similar asset, providing an opportunity to perpetuate and renew the company's activity for an indefinite period of time and totally relevant for efficient accounting management. The assets depreciation/devaluation is typically calculated on an annual basis. As a simple example of how depreciation works, we can use vehicles and the IPVA tax. Every year, the car naturally devalues, and the IPVA paid on it decreases.

Depreciation methods considered in Equity Management

There are a few basic methods for calculating the depreciation of the assets::

• Linear Depreciation (classic model): In the linear model, depreciation is calculated by applying a constant depreciation rate to the asset that loses the same value each year. The depreciation is calculated considering the asset's average useful life. Let's consider, for example, the initial value of the asset at 100% (0% wear and tear). If its useful life is 5 years, its linear depreciation is 20% per year, or 100/5.

• Depreciation by Use: model occasionally used to calculate the depreciation of production line machines. In this model, an average of how many units a machine is capable of producing during its useful life is calculated, and the machine depreciates in a non-linear way as it produces. Considering for example that a plastic injection molding machine is capable of producing 400,000 parts during its useful life, if it produces 125,000 units in one year, it will lose 31% of its value. Besides units produced, we can also count hours of use in this model. The procedure is exactly the same.

Accelerated depreciation

Depreciation is calculated as standard taking into account that a machine or vehicle produces for a maximum of 8 hours a day. However, in practice, it may be that a vehicle or machine produces all day long, being operated in several shifts by several different people, in which case we have the so-called accelerated depreciation. In this model, depreciation can be accelerated by applying 3 coefficients depending on how much the asset is required:

• Normal depreciation (coefficient = 1): occurs when the asset is used for 1 shift of 8 hours per day.
• Accelerated depreciation (coefficient = 1.5): occurs when the good is used in 2 shifts of 8 hours per day.
• Maximum Devaluation (coefficient = 2): occurs when the good is used in 3 shifts of 8 hours. Maximum use and maximum depreciation.

Revaluation of Equity Assets

But what if after the asset is fully depreciated, it is still in usable condition? A vehicle, for example, that depreciates completely in five years, what if it is still roadworthy after this period? In this case, we must perform the so-called revaluation of the asset, in which case the asset is revalued, a new value is assigned to it, and depreciation restarts.

Depreciation Table

Below is a basic table summarizing how assets are depreciated under Brazilian law:

With the change in Statute no. 11.638, there is the possibility of Reduction to the Recoverable Value of Assets, being necessary to evaluate the assets of the venture to check this possibility.