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Methods of Calculating Depreciation | Concepts and Formulas of depreciation

Depreciation is the reduction in the value of Tangible/ Intangible Non-current assets over their useful life. Depreciation of intangibles is called Amortization.

Depreciation is calculated to keep Non-current assets at Netbook value. So, assets are not overstated in the Statement of financial position. Depreciation is an expense in nature and is charged to profit & loss/ statement of comprehensive income, while Accumulated Depreciation is a contra asset, and it is subtracted from Property, plant & equipment, or other depreciable assets in the statement of financial position.

Typically Depreciation can be calculated by dividing the cost of an asset by its useful life. However, there are five following methods to calculate depreciation.

1). Straight-line Method

This is the simplest method where the cost of an asset is divided by the estimated useful life after subtracting Residual/ Salvage value from cost.

Formula: (cost-salvage value)÷Remaining useful life

2). Diminishing/ Reducing Balance Method

In the diminishing balance method, the estimated percentage is applied on cost in year one, and in the subsequent years, the estimated percentage is applied to the Netbook value of the asset. Netbook value is calculated by subtracting Accumulated Depreciation from the cost of the asset.
Formula,
Year 1: Cost of Asset×Depreciation Percentage%.
Year 2: NBV×Depreciation Percentage%.
The formula for calculating Depreciation percentage under the reducing balance method is as under:
n=Remaining useful life.

3). Sum of the year Digits

This method proportionate's the Depreciable cost of the Asset in the Remaining useful life divided by the sum of the year Digits. A formula for Depreciation under the sum of the year digits is as under:

(Cost-Salvage value)×(Remaining useful life÷Sum of the year digits)

4). Production units Method

This method is applied when useful life Machines or Plants are limited by Budgeted production units. This is typically applied in Big production units where overheads must be controlled to keep costs low. Depreciation is calculated by proportionating Depreciable cost in Produced units divided by Budgeted production capacity. A formula for Depreciation expense under Production units methods is:

(Cost-Salvage value)×(Produced Units÷Production capacity)

5). Production Hours Method

Same as above, but in this Method, Depreciation is calculated by Production Hours in a financial year. A formula for production hours is as under:

(Cost-Salvage value)×(Used Production hours÷Maximum Production hours)

 6). Revaluation method

This method is used to calculate the Depreciation expense of loose tools and other small office equipment. Depreciation is calculated by comparing the market/ fair value of assets at the start, and end of the year.
The formula is as under:

(Fair value at the start of the year + Additions ( Newly purchased assets ) - Disposal at Net Book value - Fair value at end of the year)

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