Methods of Depreciations

An accounting or economic method used to check the cost of a physical asset over the asset’s active life expectancy or useful life activity is referred to as the term depreciation. The depreciation represents the value of an asset in use. Revenues are earned by companies from assets while expending a quantity of each year’s cost asset in use with the help of depreciating assets. A company’s profit can be affected if the depreciation is not accounted for. In simpler words, the cost of using tangible assets with the advantage gained over its useful active life is bound by the depreciation. The accumulated depreciation is the aggregate of all recorded depreciation on an asset to a specific date.

What is Depreciation?

Equipment and machinery are such expensive assets. Companies or businesses use depreciation methods to branch out the cost, generating revenue instead of the total asset price in one year. Depreciation allows a company to depict the value of an asset over some time. Depreciation can also be used to account for declines over time, which is represented by the difference between the original price or cost and the accumulated depreciation over the years.  

Companies can shift the asset’s cost to the income statement from the balance sheet if the depreciation is not calculated carefully. When an asset is purchased, the company’s transaction of purchase of that asset is recorded as a debit for increasing an asset count on the balance sheet and then that asset is added to the credit to lessen the cash which is also on the balance sheet. 

Depreciation example

Suppose a company has acquired a delivery truck as an asset, and it costs 1 lakh rupees, and the expected usage of that truck is 5 years; the company might depreciate the asset under depreciation expenses as 20 thousand rupees every year over the entire time of 5 years. 

Mention the Types of Depreciation methods.   

To calculate depreciation of the company, there are several methods, which are generally based on either the passage of time or on the level of activity of the assets.

Straight-line Depreciation 

The most simple and often used method is the Straight-Line Method. With this method, depreciation is calculated by dividing the difference between assets’ cost and expected salvage value by the number of years for its useful life. The depreciation formula for the straight-line method:  annual depreciation expense = cost fixed asset – residual value/useful life of the asset (years). 

Diminishing Balance Method 

The diminishing balance method or the double-declining method is used to calculate an asset’s accelerated depreciation rate against its non-depreciation balance during earlier years of assets’ useful life. The salvage value is not considered in determining the annual depreciation in the diminishing method. Still, the book value of the asset being depreciated should never come down below its salvage value. 

Annuity depreciation 

The Annuity method of depreciation is based on annuity and not time, like how many miles the car is driven or the cycle count of a machine. Its level of activity measures the life of an acquired asset.   

Sum-of-years-digits Method 

A depreciation method that results in a more accelerated write-off than the straight-line method and also more accelerated than the diminishing-balance method is the Sum-of-years-digit method. The annual depreciation is decided by multiplying the depreciable cost of the schedule of fractions in this method. This is the only method that assumes that assets are more productive when they are newly purchased, and their productivity falls as they get old.   

Unit-of-production Depreciation Method. 

The unit-of-production depreciation method calculates the greater deductions for depreciation in years when the asset is heavily used. The depreciation formula for that is: – annual depreciation expense = cost of fixed asset-residual value/ estimated total production * actual production. 

Group Depreciation Method 

Multiple assets accounts are depreciated using the group depreciation method. This method combines the assets which are similar in nature and have approximately the same useful active life expectancy such as equipment for office or delivery trucks travelling the same distance each year. 

Composite Depreciation Method. 

The composite depreciation method is applied to multiple collections of assets that are not similar and have different services like equipment of office printers and computers are not same, they perform different functions but both are part of office equipment.

Conclusion

Depreciation allows a company to depict the value of an asset over some time. An accounting or economic method used to check the cost of a physical asset and over the assets, active life expectancy or useful life activity is referred to as the term depreciation. The depreciation represents the value of an asset in use. When an asset is purchased, the company records the transaction purchase of that asset as a debit to increase the asset account and then add it in the credit to lessen cash on the balance sheet. The aggregate of all recorded depreciation on an asset to a specific date is called Accumulated depreciation.