Recently watched [this video](https://www.youtube.com/watch?v=ztHZj6QNlkM) which puts a significant chunk of the cost of owning the vehicle into depreciation. Wouldn’t the loss in value of the vehicle only matter to me if I bought this car with the intent to sell it in the future? I *could* drive the car until the engine block falls apart and it becomes basically unsellable.
In: 2782
If you buy a $20,000 dollar car, and junk it and replace it every 20 years, it has cost you, on average, $1000 per year. That’s depreciation.
If you drive a car until it is worth nothing, then your depreciation is 100% of the car’s value. Let’s look at two scenarios:
You buy a car for $20,000 and drive it for 15 years at which point the engine blows up. A local scrapyard pays you $250 for the car and comes to tow it away. Your depreciation was $19,750 (98.75%) over 15 years, or about $1,317 per year.
You buy a car for $20,000 and drive it for 10 years at which point you sell the car for $4,000. Your depreciation was $16,000 (80%) over 10 years, or about $1,600 per year.
In both cases, the loss of value represents a cost to you. Most people tend to focus on their cash flow, but ignore their balance sheet. Your income statement tells you about your income and expenses, but it doesn’t consider the value of assets.
For example, if you buy a car for $20,000 cash, that cash immediately leaves your bank account, but you receive an asset in exchange for the cash. In finance terms, you’ve exchanged one asset (cash) for another asset (a car). The dollar value of the car goes down over time, so from an accounting perspective, we would track the value of the car just like we would the cash balance of a bank account. At the end of your term of ownership, you would typically convert the car back to cash by selling it. That’s why it’s important to track depreciation.
Used Hondas on good shape are incredibly valuable at the moment. I know it’s just a moment but there’s that.
I mean, if you don’t factor in depreciation then you instead have to factor in the cost of purchasing the car amortized over the life of the vehicle.
If the car costs $10,000 and you drive it for ten years before dumping it in a lake then the yearly cost of that car is $1,000 in addition to the costs for licensing, repairs, insurance, etc.
But that is essentially the same as factoring in depreciation, you just let it depreciate all the way to 0.
I think a lot of people simply look at property ownership through a lens of investment. They don’t buy to own. They buy to flip for growth and profit, i.e., scalp.
But for example I bought a new car six years ago for about $26,000 (final price with interest included). It’s currently worth $20,000 and I own it outright. Even if I wanted to resell right now, $6k ‘depreciation’ to me just means I got to drive a new car for $1k/yr. I call that a win. Someone who looks at property ownership through a lens of investment would call it a loss. But I think that perspective is cancerous.
Depreciation is just a fancy way of describing the purchase price of the car.
If you buy a $20k car and drive it until it falls apart, you *will* eventually have to buy a new car to replace it. That $20k is gone forever, and has to be accounted for in the cost of ownership.
Depreciation is an accounting method that says that $20k is lost gradually over the life of the vehicle, since you *could* sell it early and recover some of that $20k if you wanted to.
Some people buy new cars every couple of years and sell the old one, some people buy used ones and drive them until they die, some people lease them, but every car owner spends some money on the physical car itself, and amortization is a good way to average that out for everyone.
Look at it the other way. If you DON’T consider the value of the car over the time you own it, you’re not really getting an accurate cost of ownership.
If I buy a brand new car for $40k and drive it for one year, that doesn’t mean that it costs $40k/year to own it. I have to subtract off the value that the car still has. Because I don’t need to spend another $40k next year. But if you drive that car for 40 years (somehow), there’s probably not a lot left that needs subtracting.
So like you said, if you are driving it with the intent to never sell it, that final value might be the $50 it’s worth as scrap metal.
And similarly, when you start with a car that’s worth very little, depreciation isn’t going to have much of an impact.
Jesus… a lot of terrible answers in here.
Depreciation is an accounting tool to get an asset that gets “used up” off the books. A car gets used up, we can generally thumb how long that will take and start depreciating the asset right away.
The reason is when doing “the books” say we have 10k in cash on there. So our assets are 10k. Well we buy a car with it. Our assets are still 10k. But after 3 years that car just isn’t worth 10k anymore and we need our assets to reflect that.
So we depreciate certain assets.
Depreciation is recognizing the cost today of replacing an item in the future, based on how much of it you used up.
In the business world this is important because if you don’t take that loss of value into consideration, it can misrepresent the company’s actual profitability by failing to take into account that some portion of your revenue will need to go to investing in new equipment eventually to stay at the current level.
The IRS typically allows businesses 7 years to “straight line” depreciate assets, but companies can use any of a number of ways under generally accepted accounting principles to depreciate assets’ book values. These could be units produced, cumulative uptime, % of service life, etc. This is the major basis of the “tax-book difference” of assets, and one reason why companies have tax credits that appear to reduce their tax rate in a given year: they may have depreciated an asset only 1/10 if its value one year, but they could only claim 1/7 of its value on taxes, for example.
Anyway, as it relates to personal finance, the fact that your vehicle is going to have no value to you at some point (regardless of when) means that you should be treating the replacement of the vehicle as a cost you need to account for today.
Latest Answers