There are several methods for calculating depreciation, generally based on either the passage of time or the level of activity (or use) of the asset.
Straight-line depreciation Straight-line depreciation is the simplest and most often used method. The straight-line depreciation is calculated by dividing the difference between assets pagal sale cost and its expected salvage value by the number of years for its expected useful life. (The salvage value may be zero, or even negative due to costs required to retire it; however, for depreciation purposes salvage value is not generally calculated at below zero.) The company will then charge the same amount to depreciation each year over that period, until the value shown for the asset has reduced from the original cost to zero.
Straight-line method: :\mbox{annual depreciation expense} = {\mbox{cost of fixed asset} - \mbox{residual value} \over \mbox{useful life of asset} (years)} DE=(Cost-SL)/UL For example, a vehicle that depreciates over 5 years is purchased at a cost of $17,000 and will have a salvage value of $2000. Then this vehicle will depreciate at $3,000 per year, i.e. (17-2)/5 = 3. This table illustrates the straight-line method of depreciation.
Book value at the beginning of the first year of depreciation is the original cost of the asset. Book value equals original cost minus accumulated depreciation.
book value = original cost − accumulated depreciation Book value at the end of year becomes book value at the beginning of next year. The asset is depreciated until the book value equals scrap value. If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess would be considered a gain and subject to
depreciation recapture. In addition, this gain above the depreciated value would be recognized as
ordinary income by the tax office. If the sales price is ever less than the book value, the resulting capital loss is tax-deductible. If the sale price were ever more than the original book value, then the gain above the original book value is recognized as a
capital gain. If a company chooses to depreciate an asset at a different rate from that used by the tax office, then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit.
Diminishing balance method The double-declining-balance method, or reducing balance method, is used to calculate an asset's accelerated rate of depreciation against its non-depreciated balance during earlier years of assets useful life. When using the double-declining-balance method, the salvage value is not considered in determining the annual depreciation, but the book value of the asset being depreciated is never brought below its salvage value, regardless of the method used. Depreciation ceases when either the salvage value or the end of the asset's useful life is reached. Since double-declining-balance depreciation does not always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life. The double-declining-balance method is also a better representation of how vehicles depreciate and can more accurately match cost with benefit from asset use. The company in the future may want to allocate as little depreciation expenses as possible to help with additional expenses. With the declining balance method, one can find the depreciation rate that would allow exactly for full depreciation by the end of the period, using the formula: \mbox{depreciation rate} = 1 - \sqrt[N]{\mbox{residual value} \over \mbox{cost of fixed asset}}, where N is the estimated life of the asset (for example, in years).
Annuity depreciation Annuity depreciation methods are not based on time, but on a level of Annuity. This could be miles driven for a vehicle, or a cycle count for a machine. When the asset is acquired, its life is estimated in terms of this level of activity. Assume the vehicle above is estimated to go 50,000 miles in its lifetime. The per-mile depreciation rate is calculated as: ($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30 per mile. Each year, the depreciation expense is then calculated by multiplying the number of miles driven by the per-mile depreciation rate.
Sum-of-years-digits method Sum-of-years-digits is a spent depreciation method that results in a more accelerated write-off than the straight-line method, and typically also more accelerated than the declining balance method. Under this method, the annual depreciation is determined by multiplying the depreciable cost by a schedule of fractions. Sum of the years' digits method of depreciation is one of the accelerated depreciation techniques which are based on the assumption that assets are generally more productive when they are new and their productivity decreases as they become old. The formula to calculate depreciation under SYD method is: SYD depreciation = depreciable base x (remaining useful life/sum of the years' digits) depreciable base = cost − salvage value Example: If an asset has original cost of $1000, a useful life of 5 years and a salvage value of $100, compute its depreciation schedule. First, determine the years' digits. Since the asset has a useful life of 5 years, the years' digits are: 5, 4, 3, 2, and 1. Next, calculate the sum of the digits: 5+4+3+2+1=15 The sum of the digits can also be determined by using the formula (n2+n)/2 where n is equal to the useful life of the asset in years. The example would be shown as (52+5)/2=15 Depreciation rates are as follows: 5/15 for the 1st year, 4/15 for the 2nd year, 3/15 for the 3rd year, 2/15 for the 4th year, and 1/15 for the 5th year.
Units-of-production depreciation method Units-of-production depreciation method calculates greater deductions for depreciation in years when the asset is heavily used :\mbox{annual depreciation expense} = {\mbox{cost of fixed asset} - \mbox{residual value} \over \mbox{estimated total production}} \times \mbox{actual production} DE= ((OV-SV)/EPC) x Units per year Suppose an asset has
original cost $70,000,
salvage value $10,000, and is expected to produce
6,000 units.
Depreciation per unit = ($70,000−10,000) / 6,000 = $10 10 × actual production will give the depreciation cost of the current year. The table below illustrates the
units-of-production depreciation schedule of the asset. Depreciation stops when book value is equal to the scrap value of the asset. In the end, the sum of accumulated depreciation and scrap value equals the original cost.
Group depreciation method The group depreciation method is used for depreciating multiple-asset accounts using a similar depreciation method. The assets must be similar in nature and have approximately the same useful lives.
Composite depreciation method The composite method is applied to a collection of assets that are not similar and have different service lives. For example, computers and printers are not similar, but both are part of the office equipment. Depreciation on all assets is determined by using the straight-line-depreciation method.
Composite life equals the total depreciable cost divided by the total depreciation per year. $5,900 / $1,300 = 4.5 years.
Composite depreciation rate equals depreciation per year divided by total historical cost. $1,300 / $6,500 = 0.20 = 20%
Depreciation expense equals the composite depreciation rate times the balance in the asset account (historical cost). (0.20 * $6,500) $1,300. Debit depreciation expense and credit accumulated depreciation. When an asset is sold, debit cash for the amount received and credit the asset account for its original cost. Debit the difference between the two to accumulated depreciation. Under the composite method, no gain or loss is recognized on the sale of an asset. Theoretically, this makes sense because the gains and losses from assets sold before and after the composite life will average themselves out. To calculate composite depreciation rate, divide depreciation per year by total historical cost. To calculate depreciation expense, multiply the result by the same total historical cost. The result will equal the total depreciation per year again. Common sense requires depreciation expense to be equal to total depreciation per year, without first dividing and then multiplying total depreciation per year by the same number. ==Tax depreciation==