Methods of calcuating depreciation

The charge of depreciation can impact the net profit in the income statement, so the methods of calcuating depreciation is very important. Adopting different methods of calculation, the result will be different. And it’ll refer to the expense and tax in the income statement. Choosing the fit methods of calcuating depreciation, it need to be faced by the finance staff.

There’re several possible methods of calcuating depreciation:

1. straight line method of depreciation
2. reducing balance method
3. sum of the digits method
4. revaluation method.

Straight line method

It’s the simplest amd most popular methods of calcuating depreciation. Under this method the depreciation charge is constant over the life of the asset. And we need know three pieces of information:

1. the original (historical) cost of the asset
2. an estimate of its useful life to the business
3. an estimate of its residual value at the end of its useful life.

Annual depreciation charge = (Orginal – Residual value)/Estimated useful value

For example, a company puerchased a car on 1 January at a cost of $24,000. The company estimates that its useful life is four years, after which he will trade it in for $4,000. The annual depreciation charge is to be calculated using the straight line method.

Depreciation charge = ($24,000 – $4,000)/4= $5,000 p.a.

Reducing balance method

Under this method the depreciation charge will be higher in the earlier years of the life of the asset. Here needs a percentage to apply. And in the first year the percentage is applied to cost but in subsequent years it’s applied to the asset’s net book value (alternatively known as written down value).

The net book value (NBV) or written down value (WDV) of a non-current asset is its original cost less the accumulated depreciation on the asset to date.

For example, a trader purchased an item of plant for $1,000. The depreciation charge for each of the first five years is to be calculated, assuming the depreciation rate on the reducing balance to be 20% p.a.

The fixed depreciation is related to: useful life of asset (years), residual value of the asset and cost of the asset.

Sum of the digits method

The aim of this method is to show a higher depreciation charge in the early years of the life of an asset.

For example, the cost of asset is $4,200, the scrap value is $200, the estimaged usefullife is four years.

Sum of digits: 4 years + 3 years + 2 years + 1 years =10

Revaluation method

When a non-current asset has been revalues, the charge fro depreciation should be based on the revalued amount and the remaining useful economic life of the asset. Therefore, because of the revaluationm the depreciation is higher than previously. And an upward revaluation has resulted in a higher depreciation charge to the income statement.

Related posts:

1. Straight line method of depreciation
2. Reducing balance method
3. Property, plant and equipment
4. Revaluation method
5. Sum of the digits method