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 |