What Are Several Ways to Depreciate an Asset?
Depreciation is used to account for the cost of a company's fixed asset over time. Managers can calculate depreciation using several methods. The two major categories of depreciation include straight line and accelerated depreciation methods. The depreciation method you choose affects the accounts of your financial statements. Therefore, you must understand the different methods and choose the appropriate one for you business.
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Straight Line
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The straight-line depreciation method is the simplest way to depreciate an asset. The straight-line method depreciates a fixed amount every year until the asset is fully depreciated. To depreciate an asset using the straight-line method, subtract the salvage value of the asset from the asset's original value, and divide the result by the useful life of the asset. For example, if your company buys a bulldozer valued at $30,000 with a salvage value of $5,000 and a useful life of five years, your annual depreciate expense is $5,000, or ($30,000 - $5,000)/5.
Double Declining Balance
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The double declining balance method is an accelerated version of the straight-line method. The formula for the double declining balance method is: value of the asset divided by useful lifespan of the asset, multiplied by two. To calculate depreciation using this method, you must first calculate the depreciate rate but using the formula: (100 percent/useful life) x 2. For example, your company purchased a forklift for $40,000 with a salvage value of $2,000 and a useful life of four years. Your depreciation rate is .50, or (100 percent/4) x 2. Your depreciation expense for the first year is $19,000 ($38,000 x .50). The depreciation expense for the second year is $9,500 ($19,000 x .50). The depreciation expense for the third and fourth years are $4,750 ($9,500 x .50) and $2,375 ($4,750 x .50), respectively.
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Sum of Years’ Digits
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To calculate depreciation using the sum of years’ digits method, you must estimate the useful life of the asset. Once you know the useful life in years, count back to one and add all of the years together. For example, if the useful life is 3, the sum of years equals 6 (3+2+1). You then calculate the depreciation based on a fraction of the useful life and sum of years. The first year is 3/6 (.50), the second year is 2/6 (.333) and the third year is 1/6 (.167). For example, your company purchased a printing machine for $5,000 with a salvage value of $400 and a useful life of three years. The first year depreciation is $2,300 ($4,600 x .50). The second year is $1,531.80 ($4,600 x .333), and the third year is $768.20 ($4,400 x .167).
Units of Production
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The units of production depreciation method calculates depreciation based on how much the asset is used. To calculate depreciation under this method, you must estimate the number of units the asset will produce. You then calculate the cost per production unit by taking the value of the asset minus the salvage value and dividing the total by the estimated total number of units of production. Calculate the total depreciation expense for the period by multiplying the cost per unit of production by the number of units produced. For example, your company buys a machine for $60,000 with a salvage value of $10,000. The expected production is 100,000 units, and, therefore, the cost per unit is .50, or (60,000 -10,000)/100,000. In the first year, the asset produced 60,000 units. Given the information, the depreciation expense for the year is $30,000 (60,000 x .50).
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