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Depreciation

Depreciation is the reduction in value of an asset over time. There are several methods of calculating depreciation including straight-line, units of production, double declining balance, and sum-of-the-years digits. The document provides examples and formulas for calculating depreciation expense under each method.

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42 views17 pages

Depreciation

Depreciation is the reduction in value of an asset over time. There are several methods of calculating depreciation including straight-line, units of production, double declining balance, and sum-of-the-years digits. The document provides examples and formulas for calculating depreciation expense under each method.

Uploaded by

Kika Calafat
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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Lecture 10

Depreciation and its


Methods.
What Is Economic Depreciation?
 Economic depreciation is a measure of the
decrease in the market value of an asset over
time from influential economic factors.
Depreciation :
 It is the reduction in the value of an asset that
occurs over time due to usage, wear and tear,
or obsolescence.
Methods of Depreciation

 There are several method of depreciation and


different formulas for determining the book
value of an asset. The most common
depreciation methods include:

 Straight-line
 Double declining balance
 Units of production
 Sum of years digits
1: Straight-Line Depreciation Method

 Straight-line depreciation is a very common,


and the simplest, method of calculating
depreciation expense. In straight-line
depreciation, the expense amount is the
same every year over the useful life of the
asset.
 Depreciation Formula for the Straight Line

Method:
 Depreciation Expense = (Cost – Salvage value)

/ Useful life
Example
Consider a piece of equipment that costs
$25,000 with an estimated useful life of 8
years and a $0 salvage value.

Depreciation Expense = (Cost – Salvage value)


/ Useful life

Depreciation Expense = ($25,000 – $0) / 8 =


$3,125 per year
2: Units of Production Depreciation Method

 The units-of-production depreciation method


depreciates assets based on the total number
of hours used or the total number of units to
be produced by using the asset, over its
useful life.
 The formula for the units-of-production method:
 Depreciation Expense = (Number of units
produced / Life in number of units) x (Cost –
Salvage value)
Example
Consider a machine that costs $25,000, with an
estimated total unit production of 100 million and a
$0 salvage value. During the first quarter of activity,
the machine produced 4 million units.

To calculate the depreciation expense using the


formula
Depreciation Expense = (Number of units produced /
Life in number of units) x (Cost – Salvage value)

Depreciation Expense = (4 million / 100 million) x


($25,000 – $0) = $1,000
3: Double Declining Balance
Depreciation Method
The method reflects the fact that assets are
typically more productive in their early years
than in their later years – also, the practical fact
that any asset (think of buying a car) loses
more of its value in the first few years of its
use. With the double-declining-balance
method, the depreciation factor is 2x that of
the straight-line expense method.
 Example
 Consider a piece of property, plant, and

equipment (PP&E) that costs $25000, with an


estimated useful life of 8 years and a $2,500
salvage value. To calculate the double-
declining balance depreciation, set up a
schedule:
The information on the schedule is
explained below:
The beginning book value of the asset is filled in at the beginning
of year 1 and the salvage value is filled in at the end of year 8.
The rate of depreciation (Rate) is calculated as follows:
Expense = (100% / Useful life of asset) x 2
Expense = (100% / 8) x 2 = 25%
or
Depreciation Expense =1/estimated working life x 2 x balance
 3. Multiply the rate of depreciation by the
beginning book value to determine the expense
for that year. For example, $25,000 x 25%
(0.25)= $6,250 depreciation expense.
 4. Subtract the expense from the beginning book
value to arrive at the ending book value. For
example, $25,000 – $6,250 = $18,750 ending
book value at the end of the first year.
 5. The ending book value for that year is the
beginning book value for the following year. For
example, the year 1 ending book value of
$18,750 would be the year 2 beginning book
value. Repeat this until the last year of useful life.
4: Sum-of-the-Years-Digits
Depreciation Method
 The sum-of-the-years-digits method is one
of the accelerated depreciation methods. A
higher expense is incurred in the early years
and a lower expense in the latter years of the
asset’s useful life.
 The depreciation formula for the sum-of-

the-years-digits method:
 Depreciation Expense = (Remaining life /

Sum of the years digits) x (Cost – Salvage


value)
Example:
 An item of equipment acquried on january 1
at a cost of $100,000 has an estimated life of
10 years.required assuming that the
equipment will have a salvage value of
$10,000 determine the depreciation for each
of the first three years.
 formula
 Depreciation Expense =remaining no of
year/sum of total no of year x(cost – salvage
value)
 Depreciation Expense =remaining no of
year/sum of total no of year x(cost – salvage
value)
 Sol:
 10+9+8+7+6+5+4+3+2+1=55
 For year 1:

10/55x (100,000-10,000)=16363
For year 2:
9/55x(90,000)=14727
For year 3:
8/55x (90,000)=13090
Example
Consider a piece of equipment that costs
$25,000 and has an estimated useful life of 8
years and a $0 salvage value. To calculate the
sum-of-the-years-digits depreciation,
 The information in the schedule is explained below:
 The depreciation base is constant throughout the years and is
calculated as follows:
 Depreciation Base = Cost – Salvage value
 Depreciation Base = $25,000 – $0 = $25,000
 2. The remaining life is simply the remaining life of the asset.
For example, at the beginning of the year, the asset has a
remaining life of 8 years. The following year, the asset has a
remaining life of 7 years, etc.
 3. RL / SYD is “remaining life divided by sum of the years.” In
this example, the asset has a useful life of 8 years. Therefore,
the sum of the years would be 1 + 2 + 3 + 4 + 5 + 6 + 7 + 8
= 36 years. The remaining life in the beginning of year 1 is 8.
Therefore, the RM / SYD = 8 / 36 = 0.2222.
 4. The RL / SYD number is multiplied by the depreciating
base to determine the expense for that year.
 5. The same is done for the following years. In the beginning of year
2, RL / SYD would be 7 / 36 = 0.1944. 0.1944 x $25,000 = $4,861
expense for year 2.

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