Generally, the depreciation of a company’s stock is used to calculate a more precise and realistic value of the stock. Depreciations of the stock will be posted as a credit in the company’s financial assets balance, and flow through the Profit & Loss (P&L) as a debit, so that the depreciation value will be booked as a cost, and reduce the overall result/profit.

In short, depreciation of the stock can be seen as an accrual to the result that seeks to quantify the financial risk in the stock value, where companies can take the loss in a structured manner, and communicate a more realistic stock value to external stakeholders.

There can be many reasons for depreciating stock. Some reasons could include.

1. Materials on stock with low or no turnover. (Quantity Risk)

2. Damaged stock: Damaged stock that cannot be applied into production at its previous value (Technical Risk)

3. Obsolescence: New materials have made old materials obsolete (Technical Risk)

4. Durability: Some materials may be at risk to run out before consumption. (Technical Risk)

5. Etc.

Span of depletion.
A very common approach to perform depreciations is based on the term “Span of Depletion”. Span of depletion looks at the consumption pr. material over the last 12 months, and divides this consumption into the current quantity on stock. By doing this, you will be able to theoretically analyze the expected span of time before depletion. The span of depletion approach is normally used to evaluate the depreciation of materials that have no other problems than a low turnover. When identifying the risk of slow moving materials, it is also oftentimes referred to as quantity risk.

Example:

Material xxx
Material Value: 10 USD pr. pcs.
Current quantity on stock = 65
Total Value = 65 * 10 USD = 650 USD
Consumption in last 12 months = 5 pcs.
Span of depletion = 13 Years (65 pcs/ 5 pcs)

When having analyzed the span of depletion, the value of depreciation is determined by applying the rules governing the depreciation.

Example:

Span of depletion 0-1 Years = 0%
Span of depletion 1-2 Years = 25%
Span of depletion 2-3 Years = 50%
Span of depletion Above 3 Years = 75%

In our small example, the span of depletion was 13 years, which means that we depreciate 75% of the value.

Total depreciation = 650 USD - 75% = 487.5 USD

The value of 487.5 USD must be credited to the stock balance and be debited as a cost to the P&L.

Damaged stock or obsolete stock will normally be treated differently, and depreciated with a flat assumption. Damaged or obsolete stock that cannot be reused or revitalized may be depreciated with 90%, which supposes a total loss of the material incl. a potential 10% scrap value. The risk of non-curable materials is oftentimes referred to as technical risk.