How to Calculate Depreciation Using Straight Line Method and Other methods

Understanding how to calculate depreciation using the straight line method and other methods is very important to every business. However, depreciation is treated as expenses in the income statement as well as deducted from the value of the asset to determine its carry amount (net book value) in the statement of financial position (balance sheet). So, this article explains the meaning and how to calculate depreciation using the straight line method and the other 4 methods of depreciation.

What is depreciation

Depreciation is the gradual reduction in the value of a non-current asset (fixed asset) as a result of wear and tear, obsolescence, the passage of time, and others. Depreciation is a systematic allocation of the depreciable value of a non-current asset on its economic useful life (IAS 16). However, the depreciable amount is the difference between the asset’s cost and scrap or residual value. Useful life simply refers to the period for which a non-current asset will be available for use by an organization or the total units that an organization is expecting from the asset.

5 methods of depreciation

Calculation of depreciation cost depends on the method adopted by the organization. Meanwhile, there are many methods of calculating depreciation, but 4 four main methods include:

  • Straight line method
  • Reducing balance method or declining balance method
  • Sum of the years’ digits method
  • Productive output or machine output method
  • Service-hour or machine-hour method

Straight line method of depreciation

The straight line method of calculating depreciation expense is the simplest and most common method. The straight line method of depreciation is the systematic allocation of an equal amount over the useful life of a non-asset. Under this method, the same amount is charged every year as a depreciation throughout the asset’s useful life.

The depreciation formula for a straight line is as thus:

Example Company A purchases a machine worth $110,000 on January 1, 2002, with an estimated scrap value of $10,000. The Machine is estimated to have 5 years of useful life.

However, how to calculate depreciation using this method is as thus:

Depreciation Schedule

YearOpening value
$
Depreciation
$

Accumulated depreciation
$
Closing Value
$
2002110,00020,00020,00090,000
200390,00020,00040,00070,000
200470,00020,00060,00050,000
200550,00020,00080,00030,000
200630,00020,000100,00010,000

Declining balance or reducing balance method of depreciation

The reducing balance method of depreciation is a systematic allocation of a fixed percentage of the carrying amount (NBV) of a non-current asset over its economic useful life. In the calculation of depriation under this method, a fixed rate (r) on the carrying amount of an asset is charged as depreciation every year. This method charged higher depreciation expenses in the earlier years of the asset and a low amount in the later years. Some companies chose this method because of its tax and cash flow advantages.

The depreciation formula of the declining balance method is thus:

Example Company B purchases a machine worth $110,000 on January 1, 2002, with an estimated scrap value of $10,000. The Machine is estimated to have 5 years of useful life.

However, how to calculate depreciation using this method is as thus:

r = (1 – 0.6190) x 100

r = 38% approximately

Depreciation Schedule

YearOpening value
$
Depreciation
$

Accumulated depreciation
$
Closing Value
$
2002110,00041,800 41,800 68,200
200368,20025,91667,71642,284
200442,28416,06883,78426,216
200526,2169,96293,74616,254
200616,2546,254100,00010,000

Sum of the years’ digits method

The calculation of depreciation using this method of depreciation involves the use of the number of years of the useful life of an asset in reverse order as the digits to systematically charge the depreciable amount of the asset of its economic useful life. Sum of the years’ digits method of depreciation charges higher depreciation cost at the earlier years and low amount at the later years.

The depreciation formula of the sum of the years’ digits method is thus:

Depreciation is calculated as thus:

Depreciation amount = $110,000 – $10,000 = $100,000

Depreciation schedule

Year NumberRemaining Useful lifeOpening Value
$
Depreciation
$
Accumulated depreciation
$
Closing value
$
200215110,00033,33333,33376,667
20032476,66726,66760,00050,000
20033350,00020,00080,00030,000
20044230,00013,33393,33316,667
20055116,6676,667100,00010,000

Service-hour or machine-hour method

This method allocates the depreciable amount of the asset based on the total hours it can be used to produce goods or services throughout its economic useful life. Under this method, depreciation rate (r) is determined by dividing the depreciable amount of an asset by its total hours and multiply it with hours used in each year to get annual depreciation.

The depreciation formula of the Service-hour or machine-hour method is thus:

Example

Company D purchases a machine on January 1, 2002, worth $110,000 with an estimated scrap value of $10,000. The machine has an expected useful life of 5 years. During the useful life of the asset, the following hours of operations were obtained:

Year                                         Hours

2002                                        15,000

2003                                        12,000

2004                                        10,000

2005                                        8,0000

2006                                        5,0000

However, how to calculate depreciation using this method is as thus:

Depreciation Schedule

YearOpening value
$
Depreciation
$

Accumulated depreciation
$
Closing Value
$
2002110,00030,000 30,000 80,000
200380,00024,00054,00056,000
200456,00020,00074,00036,000
200536,00016,00090,00020,000
200620,00010,000100,00010,000

Productive output method

This method allocates the depreciable amount of the asset based on the units of goods produced by the asset. So, the economic useful life of the asset is determined by the total units it can produce. Under this method, depreciation rate (r) is determined by dividing the depreciable amount of an asset by its total units and multiply it with total units produced each year to get annual depreciation expense.

The depreciation formula of the productive output method is thus:

Company E purchases a machine on January 1, 2002, for $110,000 with an estimated scrap value of $10,000. The machine has an expected useful life of 5 years. During the useful life of the asset, the following units were produced:

Year                                         Units produced

2002                                        8,000

2003                                        6,000

2004                                        5,000

2005                                        4,000

2006                                        2,000

However, how to calculate depreciation using the productive output method is as thus:

YearOpening value
$
Depreciation
$

Accumulated depreciation
$
Closing Value
$
2002110,00032,000 32,000 78,000
200378,00024,00056,00054,000
200454,00020,00076,00034,000
200534,00016,00092,00018,000
200618,0008,000100,00010,000

Conclusion

However, how to calculate depreciation on a car, building, furniture, and other assets depends on the depreciation policy adopted by the organization. The calculation of depreciation using any of the methods of depreciation has its advantages and shortcomings to take into consideration.

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