Methods Of Accounting For Depreciation (Part 1 of 2)

July 27th, 2006 Comments off
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Whichever method we used for depreciation accounting, we must always consider the following:

  • The cost of asset,
  • The probable/estimated life of the asset and
  • The approximate residual or salvage value at the end of its life.

Generally there are several methods of depreciation:

  • Straight Line Method,
  • Reducing Balance Method,
  • Sum Of the Years Digits Method

STRAIGHT LINE METHOD OR FIXED INSTALLMENT METHOD OR STRAIGHT LINE BASIS OR FIXED PERCENTAGE ON ORIGINAL COST METHOD

Example:

A machine has an estimated life of 10 years costing $40,000 and has a residual/salvage value of $10,000

Depreciation per year is :

(Cost less Estimated residual value)/Estimated life

=$40,000-10,000=$30,000/10 years

=$3,000 per year

REDUCING OR DIMINISHING BALANCE METHOD OR FIXED PERCENTAGE ON DIMINISHING BALANCE METHOD

Example:

A machine was bought for $10,000 and a depreciation rate of 10% per annum is allowed, the depreciation is:

Year 1: Cost of machine $10,000

Less: Depreciation 10% $1,000

Reduced Balance $9,000

Year 2: Less Depreciation 10% $900

Reduced Balance $8,100

Year 3: Less Depreciation 10% $810

Reduced Balance $7,290

SUM OF THE YEARS DIGITS METHOD

This method assumes that the depreciation charge should be the heaviest in the early years of the life of the fixed asset.

It allocates annual depreciation in proportion to the number of years of an asset’s useful life which remains at the commencement of an accounting year.

Example:

A machine cost $30,000 which has an estimated life of 5 years.

Life-expectancy

1 st year 5

2 nd year 4

3 rd year 3

4 th year 2

5 th year 1

Sum of digit 15

Hence, the formula for annual depreciation is:

(Number of years of life remaining/Total of digits of years of life) x Cost less residual value which is :

Year 1: Depreciation is 5/15 x $30,000 =$10,000

Year 2: Depreciation is 4/15 x $30,000 =$ 8,000

Year 3: Depreciation is 3/15 x $30,000 =$ 6,000

Year 4: Depreciation is 2/15 x $30,000 =$ 4,000

Year 5: Depreciation is 1/15 x $30,000= $ 2,000

CLICK HERE FOR ALL ARTICLES ON DEPRECIATION OF FIXED ASSETS

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Financial Accounting

 
 

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