Calculate Depreciation

Depreciation is the method of reallocating, or “writing down,” the cost of a financial instrument (such as equipment) over its useful life span. Long-term assets are depreciated for accounting and tax purposes. The decrease in asset value affects a company’s or entity’s balance sheet, and the accounting method of depreciating the asset affects net income, and thus the income statement they report. Depreciation expense is typically allocated among the periods in which the asset is expected to be used.

Definition of Depreciation

Depreciation is the process of subtracting the total cost of an expensive item you purchased for your company. You write off parts of it over time rather than doing it all in one tax year. You can plan how much money is written off each year when you depreciate assets, giving you more control over your finances.

For example, the IRS may require a piece of computer equipment to be depreciated for five years, but if you know it will be obsolete in three years, you can depreciate it sooner.

Depreciation Methods and formulas

There are numerous methods for distributing depreciation over the useful life of an asset. 

Regardless of which method of depreciation is chosen, the total amount of depreciation for any In the end, the asset will be the same; the only difference will be the timing of depreciation. Remember that accelerated depreciation methods (such as declining balance or sum of the years’ digits) can artificially reduce profit in the short term, followed by higher profits in the long run, affecting reported cash flows.

The following are the most common depreciation methods:

1. Straight-line
2. Double declining balance
3. Units of production
4. Sum of years digits

Straight-line depreciation: The most common and simplest method of calculating depreciation expense is straight-line depreciation. The expense amount is the same every year over the asset’s significant life in straight-line depreciation.

Double-declining-balance: When compared to other depreciation methods, double-declining-balance depreciation results in a higher amount being expensed in the early years of an asset’s useful life versus the later years. The method takes into account the fact that assets are typically more productive in their early years than later years, as well as the practical fact that any asset (consider buying a car) loses more value in the first few years of use. The depreciation factor for the double-declining-balance method is 2x that of the straight-line expense method.

Units-of-production depreciation method: Over the useful life of the asset, 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.

Depreciation using the Sum-of-the-Years-Digits Method: One of the accelerated depreciation methods is the sum-of-the-years-digits method. Early in the asset’s useful life, a higher expense is incurred, and later in the asset’s useful life, a lower expense is incurred. The remaining life of an asset is divided by the sum of the years and then multiplied by the depreciating base to determine the depreciation expense in the sum-of-the-years digits depreciation method.

Depreciation example

If a company buys a delivery truck for Rs. 100,000 and expects to use it for 5 years, the company may depreciate the asset at a rate of Rs. 20,000 per year for 5 years.

Conclusion

Depreciation allows businesses to recover the cost of an asset they purchased. Instead of recovering the purchase price immediately, the process allows companies to cover the total cost of an asset over its lifetime. This enables businesses to replace future assets with the right amount of revenue. One of these costs is depreciation, which occurs when assets wear out and need to be replaced. Depreciation accounting tells you how much value your assets lost over the course of the year. This figure should be included on your income statement and subtracted from revenue when calculating profit.