Depreciation and different ways to calculate it

After doing my high school in India I came to United States last year with a goal in mind to be an accountant or a bean counter as you say over here

. So I joined the West Chester University which was a totally new environment and a different system of education in comparison to what I had it in India. I took my first accounting course and studied financial accounting. One of the most interesting topic to me was Depreciation and what are the different ways or the methods to calculate depreciation. So let us now discuss something about depreciation.

What is Depreciation? Depreciation is a tool used to find the cost or the value of the assets that have been used over a period of time. It reduces the value of the asset but it helps us to find the present value of the asset. It is recorded as Depreciation Expense in the general journal. The entry is recorded as a debit to Depreciation Expense and a credit to Accumulated Depreciation.

Depreciation can be calculated in three different ways. The straight line method, the unit of production method and the declining balance method. In Straight line method, depreciation expense is same at the end of each period during the asset's useful life. This is how we calculate depreciation expense using straight line method. We take the actual cost of the asset and we also estimate its salvage value which is the value of the asset at the end of its benefit period. We subtract the salvage value of the asset with the actual cost of the asset and then we divide the result by the life of the asset. For example: A machinery is worth $10,000 and its salvage value is estimated to be $1,000 and it is also given that the life of the machinery is three years, so according to this method the depreciation expense for each year would be $3,000. Each year the entry would be recorded as a debit to the depreciation expense account and a credit to accumulated depreciation account for $3,000.

Unit of production method is entirely different from straight line method. In this method, depreciation expense in each period depends upon the units produced in every period. Therefore depreciation expense does not remain same every time. Computing depreciation using unit of production involves two steps, first is to find the depreciation per unit and then the second to find the depreciation expense. Now in order to find the depreciation per unit we take the asset's salvage value and subtract it from the assets total cost and then divide the whole thing by the total number of units expected to be produced in the asset's useful life. After we got the depreciation per unit we multiply it by the total number of units actually produced in that period. This is how we find depreciation expense for each period with this method. For example: A building was bought for $20,000 in 2010. Its salvage value is $5,000. The company expects it to produce 50,000 units. But in 2010 it actually produced only 2,000 units. So in this case to find the depreciation per unit we will subtract $5,000 from $20,000 and divide it by 50,000 which is equal 0.3 and which is our depreciation per unit. Now the depreciation expense for 2010 by this method would be 0.3 times 2,000 which is equal to $600.

Declining balance method is an accelerated depreciation method in which the depreciation is highest in the first period and it gradually decreases in every period. In this method the book value of the asset is multiplied by a fixed rate. The most commonly used technique used in declining balance method is double declining balance technique. In this technique we double the rate used in the straight line method. Let us take an example, suppose a building is worth $10,000 with a salvage value of $1,000 and it has a useful life of 5 years. So the first step is to find the straight line rate that is 100% divided by 5 which equals 20%. Now using the double declining technique we will double the rate to 40%. This rate will be used to find the depreciation expense for each year. So the depreciation for the first year will be 40% of $10,000 which equals 4,000.

Remember the book value of the asset cannot be below the salvage value regardless of the method used.

I hope this helped you to understand depreciation and how it is calculated using different methods.

Vipul Arya

Depreciation and different ways to calculate it

By: Vipul Arya

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