Tuesday, 24 July 2012

Depreciation Methods

We move on to the concept of depreciation. “What is that?” I hear you ask. To put it simply it is certain amount of value that is deducted of a particular asset over a period of time.

There are various ways of depreciation depending on the type of asset, company policy or which shows the true value of the asset.

Whichever method is chosen it is best to stick to one type of method rather than changing from year to year. If this was done the assets would not be shown as their true value and it could be seen as a company messing with its books.

Depreciation of an asset is recorded as an expense in the income statement. It is also known as a misusing of an asset. It will also be seen in the capital assets section of a balance sheet where it is taken away from the original value of the asset. This will accumulate over a period of time. This is known as accumulated deprecation. 

Depreciation is used to show the true and fair value of an asset as it is used over a period of time. For instance a car that was bought in 2011 won’t have the same value in 2012 due to the car been used. It is not the same worth because it is not new not worn and cleaner. 

Straight line Depreciation

This method works by talking an equal amount of an asset over its useful economic life and charging it in the income statement as an expense. It is also the most used type of deprecation method. This states that the same value will be taken of the assets every year. This is calculated by dividing the asset by its useful economic life.
Let's see an example to understand how it works.

A company called Dall decides to by a new lorry. It cost €60,000 and had an expected useful life of 20 years. The company decides to use straight line deprecation for the lorry. The depreciation is calculated by dividing €60,000 by 20 years.  This means the company will take €3000 of value of the lorry. Next year the starting value of the lorry will be valued at €57,000.
The accumulated depreciation will be €6000 in the balance sheet at the end of year 2. This will be done again and again until the end of the assets useful life.

With certain assets there will be a residue value at the end of its useful life. The asset will either be sold for this value or kept on after its useful life.

Check out this link to learn more about straight line deprecation:

To see another example of straight line depreciation check out this video:

FA 9 3 Straight line Depreciation

Uploaded by on Feb 19, 2008

Reducing Balance Depreciation

The reducing balance depreciation is also a popular method but not as used as straight line depreciation. This is also known as the diminishing balance method. It works by a certain percentage of the book value of the assets is written off. This will mean that in the income statement will have a larger figure for depreciation for year 1 but will get progressively smaller each year.

So let's see an example of this method.

The company Fonta, decides to buy a new company car that is expected to last for 15 years in 2012. They use the reducing balance method which will deprecate the car’s value by 15% depreciation each year. 15% of €15,000 is €2750. The company will take this away from €15,000 and the car’s value is €12750 for 2013.

Check out this link to learn more about the reducing balance method:

Check out this video to see how the reducing balance depreciation method works:

Reducing Balance Depreciation  

Uploaded by on Aug 7, 2011

Sum of Digits Method

This method is not as popular as the methods above. It calculates deprecation by adding up all its expected useful years and whatever years it has left it is multiplied by the value of the asset by the year over the total expected useful years. This seems a tad confusing. Let’s see an example which will help make it clearer.

The company 7ap buy a car for €12,000. They decide to use the sum of digits method for its depreciation. The car has an expected life of 10 years. So we add the individual years as so. 10 + 9 + 8 + 7..... + 1. The answer is 55. So for the first years of deprecation it works as follows:

€12000  X    10 years              =          €2818.81

€12,000   X   9 years               =          €1963.63

And so on until the company gets to year 1. To do it manually it is time consuming and is one reason why it is not a popular form of deprecation.

To learn more about this method of depreciation check out this video:

Sum Of The Years Digits Depreciation Method.wmv  

Uploaded by on Aug 4, 2011

No comments:

Post a Comment