Legal Definitions - depreciation reserve

A depreciation reserve is a fund set up by a business to replace expensive items that lose value over time. The business puts money into the reserve every year based on the amount the item depreciates and its salvage value. This allows the business to have the funds available to replace expensive equipment as it must be replaced.

Let's say a company buys a machine for $50,000 that will last for 10 years and can be sold for $5,000 at the end of its useful life. The company would allocate $4,500 each year into a reserve account to pay for the replacement of the machine ($50,000 - $5,000 = $45,000 / 10 = $4,500).

Another example is a cruise company that must replace its new ship, which cost $100,000,000, in twenty years and the ship can be salvaged for $10,000,000 at the end of that twenty-year period. The business would allocate $4,500,000 each year into a reserve account to pay for the new ship ($100,000,000 - $10,000,000 = $90,000,000 / 20 = $4,500,000).

These examples illustrate how a depreciation reserve works by allowing a business to slowly prepare for the cost of replacing expensive equipment over time, rather than having to pay for it all at once. This helps the business avoid financial strain and plan for the future.