If maintenance/repair costs are capitalized into a fixed asset, inflation results in an increase in depreciation.
Still confused? Keep reading for a more comprehensive answer:
Depreciation is the non-cash expense that accounts for the decline in value of an asset over time due to wear and tear, or obsolescence.
And inflation is the general increase in prices and a decrease in the purchasing power of money.
In general, depreciation does not increase with inflation because the rate of depreciation is based on the historical cost of the asset, not its current market value. However, inflation increases the cost of replacing or repairing the asset.
These costs are recorded as an expense in the income statement.
However:
When maintenance costs increase the useful life of an existing asset or increase its productive capacity, they are considered capital expenditures instead.
In this case, the cost is capitalized into the asset that received the maintenance process, increasing its annual depreciation.
This means depreciation does not increase solely through capital expenditures in new assets. It can also increase by improving existing assets.
When inflation rises, the costs of repairing assets rise as well—which can indirectly affect the rate of depreciation.
For example:
Let’s say a company replaces a broken machine part with an identical one. The cost of the replacement is expensed immediately (in the income statement), as it only restores the original condition of the machine.
However, if the company upgrades to a better part, the cost should be capitalized since it improves the functionality of the machine and increases its value.
The increase in value is spread out over the years (depreciation), as opposed to being recorded as a single expense in that year.
This increase in depreciation is higher if machine parts cost more, and the price of machine parts is a function of inflation.
That’s how inflation affects depreciation.
Overall, the relationship between depreciation and inflation can be complex and depends on a variety of factors, including the specific assets being depreciated and the economic conditions at the time.
