Methods of depreciation
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This document discusses three methods of depreciation: straight line, written down value, and annuity. The straight line method evenly depreciates the asset over its useful life until its book value reaches the estimated scrap value. The written down value method uses a fixed depreciation percentage each year on the asset's declining book value. The annuity method calculates depreciation based on the asset's estimated usage, such as miles driven for a vehicle, rather than by time. Examples are provided for each method.
Methods of depreciation
- 2. Depreciation • A reduction in the value of an asset over time due in particular to wear and tear. Methods- Straight Line Method Written Down Value Method Annuity Method
- 3. Straight Line Method • Simple & widely used. • The company estimates the scrap value of the asset at the end of the period during which it will be used. • The scrap value is an estimate of the value of the asset at the time it will be sold or disposed off. • The company charges depreciation each year over that period, until the value shown for the asset has reduced from the original cost to the salvage/scrap value.
- 4. Depreciation expense Accumulated depreciation at year-end Book value at year-end (original cost) $17,000 $3,000 $3,000 $14,000 3,000 6,000 11,000 3,000 9,000 8,000 3,000 12,000 5,000 3,000 15,000 (scrap value) 2,000
- 5. Written Down Value Method • Depreciation is charged according to a fixed percentage. • Value of depreciation is calculated upon the original cost in the first year and written down value, in subsequent years. • The rate of depreciation remains constant year after year whereas the amount goes on decreasing.
- 6. Example Depreciation rate Depreciation expense Accumulated depreciation Book value at end of year original cost $1,000.00 40% 400.00 400.00 600.00 40% 240.00 640.00 360.00 40% 144.00 784.00 216.00 40% 86.40 870.40 129.60 129.60 - 100.00 29.60 900.00 scrap value 100.00
- 7. Annuity Method • Annuity method is not based on time, but on a level of Annuity. • The level of annuity could be miles driven for a vehicle, or a cycle count for a machine. • When the asset is acquired, its life is estimated in terms of this level of activity.
- 8. Example • Assume the same vehicle is estimated to go 50,000 miles in its lifetime. • The per-mile depreciation rate is calculated as: ($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30 per mile. • Each year, the depreciation expense is then calculated by multiplying the number of miles driven by the per-mile depreciation rate.