subject: Depreciation Methods [print this page] Depreciation is a very important concept to understand in accounting. It is an expense recorded to allocate a tangible asset's cost over its useful life. Different items that can be depreciated are buildings, machinery, vehicles, and furniture. In order to calculate depreciation, someone needs to know three amounts for each asset. These amounts are cost, salvage value, and useful life. After determining the amounts, three different methods can be used. They are straight-line, units-of-production, and double-declining balance.
The simplest technique is the straight-line method. To find the depreciation expense for the period, subtract the salvage value from the cost, and then divide that answer by the useful life of the asset. For example, a company buys a machine costing $50,000 with a salvage value of $5,000, and 5 useful years. First, subtract $5,000 from $50,000 to get $45,000. Then divide that by its useful life of 5 years to get a depreciation expense of $9,000. This is a very commonly used method for finding the depreciation.
Another method used is referred to as units-of-production. To make this calculation, start by subtracting the salvage value from the cost just like in the straight-line method. Then, divide that value by the total units of production to get the depreciation per unit amount. After that is done, the last step is to multiply the depreciation per unit by the number of units produced in the period. The answer is the depreciation expense for the asset. For an example, the exact same machine from the above example can produce 100,000 units during its life, and it produced 22,000 units this year. To calculate the depreciation, first subtract $5,000 from $50,000 again, and divide that number by 100,000 units. That comes out to be $.45 depreciation per unit. Then multiply the $.45 by the 22,000 units produced for a depreciation expense of $9,900.
The third method that can be used is double-declining balance. The first step is to divide 100% by the assets useful life to get the straight-line rate. Multiply that number by 2 to determine the double-declining balance rate. The last step involved is to multiply the double-declining balance rate by the beginning period book value. As an example, I'll use the same machine from the previous examples. The first step will consist of dividing 100% by the 5 useful years to arrive at a straight-line rate of 20%. To get the double-declining balance, simply multiply 20% by 2 to get 40%. Finally, to get the depreciation expense, multiply 40% by the beginning book value of $50,000. The final answer would be $20,000.
After computing depreciation of an asset, a company needs to make a journal entry for the expense. This is done by debiting depreciation expense and crediting accumulated depreciation.
