All those assets that lose their value with time and usage, are considered a depreciating asset. From an accounting perspective, this does give you some benefits. A portion of the cost of this asset can be deducted to account for the usage, wear and tear, or obsolescence, from the value of the fixed asset. This is the general practice under the matching principle as the revenues are kept along with their expenses in the accounting period thus giving a more complete picture for accounting purposes.
There are multiple ways in which depreciation is calculated when determining the book value of an asset.
The most common ones are :
- Straight-line
- Double declining balance
- Units of production
- Sum of years digits
Some of the things that one needs to understand when trying to calculate the depreciation:
The useful life of the asset:
This is basically the number of years one expects to use the asset. For accounting purposes, this number is subjective to individual considerations. For the purpose of depreciation, useful lives depend on the type of asset.
Salvage value:
This is the worth or value of the asset at the end of its useful life. Salvage value is generally an estimated value – this can be even zero if the asset is going to use for a long period.
Asset Original Cost:
The asset cost includes all costs incurred in acquiring the asset, including sales tax, transportation, set-up, training, etc.
Book Value:
Asset’s book value is the original cost minus any depreciation claimed on that asset. Obviously, this value reduces with time and usage.
Methods of Depreciation calculation
There are some common practices when it comes to how depreciation is calculated.
Straight Line Depreciation
This method is among the most common ways to depreciate a fixed asset. In this, the value is distributed evenly over the useful life of the asset. It is typically used by small businesses with simple accounting systems. It is so simple that there is no need for an accountant or tax advisor to do this calculation.
- Book Value = (Asset Cost – Salvage Value) / Useful Life
A business buys machinery for 10 Lakhs. After 10 years if Its salvage value is 1 Lakh. Thus the book value of the machinery after 10 years can be estimated to be:
(1000000 – 100000)/ 10 = 90,000
Thus every year the business would be writing off 90000 rupees as depreciation for the machinery.
Double declining balance depreciation
The double-declining balance method is more complicated than the Straight-line method in the way to depreciate an asset. This method is not a linear one. This allows the write-off of an asset’s value more in the days immediately after the purchase and less afterward. This is beneficial if a business wants to rake in the depreciation upfront.
- Depreciation (1st year) = (2 x straight-line depreciation rate) x (Original Asset Cost) )
- Depreciation (2nd year) = (2 x straight-line depreciation rate) x (Book Value of 1st year) )
In the previous example, the straight-line depreciation rate is as below:
straight-line depreciation rate = Depreciation per year / Total Depreciation
= 90000/900000
= 0.1
Thus the depreciation of the asset in the first year is 2*0.1*1000000 = 200000
The depreciation of the asset in the second year would be 2*0.1*(1000000 – 200000)
i.e. 160000
Sum-of-the-year’s-digits depreciation
This is another method of depreciation that is similar to the above. In this method too the depreciation is front-loaded. In this method, the decline is less than the double-declining balance method.
Depreciation = (remaining lifespan / SYD) x (asset cost – salvage value) where SYD is the sum digits of the remaining lifespan years.
In our example, SYD = 1+2+3+4+5+6+7+8+9+10 = 55.
asset cost = 10 L, salvage value = 1 L
Depreciation (1st year) = ( 10/55)* (1000000 – 100000)
Depreciation (2nd year) = (9/55)* (1000000 – 100000)
Units of production depreciation
The units of production method use a simple way to depreciate viz based on the usage of the asset. The usage can be calculated based on either the time it is used or based on the output produced using the asset.
This method needs the asset to have quantifiable output. In this method, asset depreciation happens more when it is used more and vice versa. The disadvantage is that one needs to track the usage and needs to keep it auditable.
depreciation = (asset cost – salvage value) / units produced in useful life
In our example above, let us assume that as per the manufacturer the asset can produce 1000000 units then depreciation = (10L – 1L)/ 1000000 units will give us the per-unit depreciation. Then depending on the production that particular year, depreciation can be calculated.
Final Notes
Depreciation is an important part of accounting practice. It helps companies provide proper perspective to the Balance sheet provided. One of the major issues as far as assets are that one tends to lose track of them. It becomes difficult to ensure that the top levels numbers can be dug down deeper and everything ties up.
The use of good accounting software obviously is important to ensure that the records are kept but it is essential to have asset tracking software that can ensure both peace of mind as well as ease of doing business.
Quicsolv provides an Asset Tracking System which is based on modern technologies and concepts of asset tracking. Talk to us to know more about it
