Methods of charging Depreciation | Concept, formulas, and Explanation

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

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

Typically Depreciation can be calculated by dividing 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 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 diminishing balance method estimated percentage is applied on cost in year one, and in the subsequent years estimated percentage is applied on Net book value of the asset. Net book value is calculated by subtracting Accumulated Depreciation from cost of asset.
Formula,
Year 1: Cost of Asset×Depreciation Percentage%.
Year 2: NBV×Depreciation Percentage%.
Formula for calculating Depreciation percentage under 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 sum of the year Digits. A formula for Depreciation under 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 Cost low. Depreciation is calculated by propotionating 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)

 

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