Useful life:
Every asset except land has a useful life over which it provides economic benefits and over which its value deteriorates and ultimately it is required to be scrapped or replaced.
Depreciation:
Depreciation is the adjustment for normal wear and tear of the asset due to its limited useful life and its usage. Depreciation adjustment basically allocates the cost of an asset over its useful life.
Depreciation methods
The two most common methods to calculate the depreciation are:
- Straight Line Method
- Reducing Balance Method
Straight Line Method
Under this method cost of an asset is allocated uniformly over its useful life. The depreciation is calculated as follows:
= Cost of an asset – Estimated disposal value (if any)
Number of years of useful life
Example:
A company purchased an asset worth $ 100,000 at the start of year 2015.The asset has an expected useful life of 5 years.
The depreciation for all 5 years would be calculated as follows:
= 100,000
5
= 20,000
The carrying value of an asset over its life would be as follows:
|
Year |
Cost |
Depreciation |
Accumulated depreciation |
Carrying value |
|
$ |
||||
|
2015 |
100,000 |
20,000 |
20,000 |
80,000 |
|
2016 |
100,000 |
20,000 |
40,000 |
60,000 |
|
2017 |
100,000 |
20,000 |
60,000 |
40,000 |
|
2018 |
100,000 |
20,000 |
80,000 |
20,000 |
|
2019 |
100,000 |
20,000 |
100,000 |
0 |
Reducing Balance Method
This method assumes that assets would be giving its peak performance/production during initial years and its usefulness/ production will deteriorate over time so the pattern of depreciation should match the productivity pattern. Under this method, depreciation is applied to the carrying value which reduces each year resulting in higher depreciation in initial years and reducing depreciation afterward.
The depreciation is calculated by multiplying the carrying value with the depreciation rate.
Example
Using the same data above and assuming a 35% depreciation rate under reducing balance method, the depreciation for the year 2015 and 2016 would be as follows
Depreciation Year 2015 = 100,000 x 35%
= 35,000
Depreciation Year 2016 = (100,000 – 35,000) x 35%
= 22,750
The carrying values over the life of asset would be as follows
|
Year |
Cost |
Depreciation |
Accumulated depreciation |
Carrying value |
|
$ |
||||
|
2015 |
100,000 |
35,000 |
35,000 |
65,000 |
|
2016 |
100,000 |
22,750 |
57,750 |
42,250 |
|
2017 |
100,000 |
14,788 |
72,538 |
27,463 |
|
2018 |
100,000 |
9,612 |
82,149 |
17,851 |
|
2019 |
100,000 |
6,248 |
88,397 |
11,603 |
Accumulated depreciation
Accumulated depreciation is the sum of depreciation recognized to date from the start of the useful life of the asset. It is netted against a fixed asset account while presenting in the balance sheet.
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