Depreciation & Depreciation methods

Definition

The monetary value of an asset decreases over time due to use, wear and tear or obsolescence. This decrease is measured as depreciation. Depreciation is a decrease in an asset's value.  

OR

A method of reallocating the cost of a tangible asset over its useful life span of it being in motion. 

Businesses depreciate long-term assets for both tax and accounting purposes. This will affects the balance sheet of a business or entity, and the latter affects the net income that they report. This expense is recognized by businesses for financial reporting and tax purposes.

in determining the net profits from an activity, the receipts from the activity must be reduced by appropriate costs. One such cost is the cost of assets used but not immediately consumed in the activity. Such cost so allocated in a given period is equal to the reduction in the value placed on the asset,  which is initially equal to the amount paid for the asset and subsequently may or may not be related to the amount expected to be received upon its disposal.

Methods of depreciation

Straight-line depreciation

 In this method, the company estimates the salvage value (scrap value) of the asset at the end of the period during which it will be used to generate revenues (useful life). The company will then charge the same amount to depreciation each year over that period, until the value shown for the asset has reduced from the original cost to the salvage value.

Declining balance method

With the declining balance method, one can find the depreciation rate that would allow exactly for full depreciation by the end of the period, using the formula:

Annuity depreciation

Annuity depreciation methods are not based on time, but on a level of Annuity. Each year, the depreciation expense is then calculated by multiplying the number of miles(Vehicle) driven by the per-mile depreciation rate.

Sum-of-years-digits method

um of the years' digits method of depreciation is one of the accelerated depreciation techniques which are based on the assumption that assets are generally more productive when they are new and their productivity decreases as they become old. The formula to calculate depreciation under SYD method is:

SYD Depreciation = Depreciable Base x (Remaining Useful Life/Sum of the Years' Digits)
Depreciable Base = Cost - Salvage Value

Example: If an asset has original cost of $1000, a useful life of 5 years and a salvage value of $100, compute its depreciation schedule.

First, determine years' digits. Since the asset has useful life of 5 years, the years' digits are: 5, 4, 3, 2, and 1.

Next, calculate the sum of the digits: 5+4+3+2+1=15

The sum of the digits can also be determined by using the formula (n²+n)/2 where n is equal to the useful life of the asset in years. The example would be shown as (5²+5)/2=15

Units-of-production depreciation method

Under the units-of-production method, useful life of the asset is expressed in terms of the total number of units expected to be produced

Depreciation stops when book value is equal to the scrap value of the asset. In the end, the sum of accumulated depreciation and scrap value equals the original cost.