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Types of Deprication
2010-07-03, 1:13 PM
Straight-line depreciation :

Straight-line depreciation is the simplest and most-often-used technique, in which the company estimates the salvage value of the asset at the end of the period during which it will be used to generate revenues (useful life) and will expense a portion of original cost in equal increments over that period. The salvage value is an estimate of the value of the asset at the time it will be sold or disposed of; it may be zero or even negative. Salvage value is scrap value, by another name.
Straight-Line Method:

For example, a vehicle that depreciates over 5 years, is purchased at a cost of US$17,000, and will have a salvage value of US$2000, will depreciate at US$3,000 per year: ($17,000 - $2,000)/ 5 years = $3,000 annual straight-line depreciation expense. In other words, it is the depreciable cost of the asset divided by the number of years of its useful life.
This table illustrates the straight-line method of depreciation. Book value at the beginning of the first year of depreciation is the original cost of the asset. At any time book value equals original cost minus accumulated depreciation.
Book Value = Original Cost - Accumulated Depreciation
Book value at the end of year becomes book value at the beginning of next year. The asset is depreciated until the book value equals scrap value.

Book Value -              Depreciation Expense        Accumulated Depreciation                 Book Value - End of Year
Beginning of Year

$17,000 (Original Cost)         $3,000                        $3,000                                                      $14,000
$14,000                                  $3,000                        $6,000                                                      $11,000
$11,000                                  $3,000                        $9,000                                                        $8,000
$8,000                                    $3,000                      $12,000                                                        $5,000
$5,000                                    $3,000                       $15,000                                                       $2,000 (Scrap Value)


If the vehicle were to be sold and the sales price exceeded the depreciated value (net book value) then the excess would be considered a gain and subject to depreciation recapture. In addition, this gain above the depreciated value would be recognized as ordinary income by the tax office. If the sales price is ever less than the book value, the resulting capital loss is tax deductible. If the sale price were ever more than the original book value, then the gain above the original book value is recognized as a capital gain.
If a company chooses to depreciate an asset at a different rate from that used by the tax office then this generates a timing difference in the income statement due to the difference (at a point in time) between the taxation department's and company's view of the profit.


Declining-Balance Method:

Depreciation methods that provide for a higher depreciation charge in the first year of an asset's life and gradually decreasing charges in subsequent years are called accelerated depreciation methods. This may be a more realistic reflection of an asset's actual expected benefit from the use of the asset: many assets are most useful when they are new. One popular accelerated method is the declining-balance method. Under this method the Book Value is multiplied by a fixed rate.
Annual Depreciation = Depreciation Rate * Book Value at Beginning of Year
The most common rate used is double the straight-line rate. For this reason, this technique is referred to as the double-declining-balance method. To illustrate, suppose a business has an asset with $1,000 Original Cost, $100 Salvage Value, and 5 years useful life. First, calculate straight-line depreciation rate. Since the asset has 5 years useful life, the straight-line depreciation rate equals (100% / 5) 20% per year. With double-declining-balance method, as the name suggests, double that rate, or 40% depreciation rate is used.
The table below illustrates the double-declining-balance method of depreciation. Book Value at the beginning of the first year of depreciation is the Original Cost of the asset. At any time Book Value equals Original Cost minus Accumulated Depreciation.
Book Value = Original Cost - Accumulated Depreciation
Book Value at the end of year becomes Book Value at the beginning of next year. The asset is depreciated until the Book Value equals Salvage Value, or Scrap Value.


Book Value -             Depreciation Rate          Depreciation Expense        Accumulated Depreciation      Book Value -End of
Beginning of Year                                                                                                                                        Year
                   
$1,000 (Original Cost)         40%                      $400                                    $400                                       $600
$600                                    40%                       $240                                    $640                                       $360
$360                                    40%                       $144                                    $784                                       $216
$216                                    40%                         $86.40                                $870.40                                $129.60       $129.60 $129.60 - $100                                      $29.60                                 $900                                 $100 (Scrap Value)

The Salvage Value is not considered in determining the annual depreciation, but the Book Value of the asset being depreciated is never brought below its Salvage Value, regardless of the method used. The process continues until the Salvage Value, or the end of the asset's useful life, is reached. In the last year of depreciation a subtraction might be needed in order to prevent Book Value from falling below estimated Scrap Value.
Since declining-balance depreciation doesn't always depreciate an asset fully by its end of life, some methods also compute a straight-line depreciation each year, and apply the greater of the two. This has the effect of converting from declining-balance depreciation to straight-line depreciation at a midpoint in the asset's life.

Activity depreciation :

Activity depreciation methods are not based on time, but on a level of activity. This could be miles driven for a vehicle, or a cycle count for a machine. When the asset is acquired, its life is estimated in terms of this level of activity. Assume the vehicle above is estimated to go 50,000 miles in its lifetime. The per-mile depreciation rate is calculated as: ($17,000 cost - $2,000 salvage) / 50,000 miles = $0.30 per mile. Each year, the depreciation expense is then calculated by multiplying the rate by the actual activity level.

Sum-of-Years' Digits Method :

Sum-of-Years' Digits is a depreciation method that results in a more accelerated write-off than straight line, but less than declining-balance method. Under this method annual depreciation is determined by multiplying the Depreciable Cost by a schedule of fractions.
Depreciable Cost = Original Cost - Salvage Value
Book Value = Original Cost - Accumulated Depreciation
Example: If an asset has Original Cost $1000, a useful life of 5 years and a Salvage Value of $100, compute its depreciation schedule.
First, determine Years' digits. Since the asset has useful life of 5 years, the Years' digits are: 5, 4, 3, 2, and 1.
Next, calculate the sum of the digits. 5+4+3+2+1=15
Depreciation rates are as follows:
5/15 for the 1st year, 4/15 for the 2nd year, 3/15 for the 3rd year, 2/15 for the 4th year, and 1/15 for the 5th year.


Book Value -          Total Depreciable Cost     Depreciation    Rate Depreciation    Accumulated Depreciation    Book Value Beginning of Year                                            Expense                                                                                          End of Year


$1,000 (Original Cost)    $900                        5/15                      $300 ($900 * 5/15)        $300                            $700
$700                               $900                         4/15                      $240 ($900 * 4/15)        $540                            $460
$460                               $900                         3/15                      $180 ($900 * 3/15)        $720                            $280
$280                               $900                         2/15                      $120 ($900 * 2/15)         $840                           $160
$160                               $900                         1/15                      $60($900*1/15)              $900                           $100  

Units-of-Production Depreciation Method :

Under the Units-of-Production method, useful life of the asset is expressed in terms of the total number of units expected to be produced. Annual depreciation is computed in three steps.

First, a Depreciable Cost is computed.
Depreciable Cost = Original Cost - Salvage Value.
Second, Depreciation per Unit is computed. Depreciation charge per unit is computed by dividing Depreciable Cost by Total Units, expected to be produced during the useful life of the asset.
Depreciation per Unit = Depreciable Cost / Total Units of production
Third, annual depreciation, or Depreciation Expense, by another name, is computed. Depreciation Expense equals Depreciation per Unit multiplied by the number of units produced during the year.
Depreciation Expense = Depreciation per Unit * Units produced during the Year.
Book Value, as always, is calculated by subtracting Accumulated Depreciation from the Original Cost.
Book Value = Original Cost - Accumulated Depreciation
Suppose, an asset has Original Cost $70,000, Salvage Value $10,000, and is expected to produce 6,000 units.
Depreciable Cost = ($70,000-$10,000) $60,000
Depreciation per Unit = ($60,000 / 6,000) = $10
The table below illustrates the Units-of-Production depreciation schedule of the asset.
Book Value -            Units of Production      Depreciation        Depreciation     Expense Accumulated      Book End of Year
Beginning of Year                                         Cost per Unit                                 Depreciation
$70,000 (Original Cost)   1,000                        $10                       $10,000              $10,000                        $60,000
$60,000                            1,100                        $10                       $11,000              $21,000                        $49,000
$49,000                            1,200                        $10                       $12,000              $33,000                        $37,000
$37,000                            1,300                        $10                       $13,000              $46,000                        $24,000
$24,000                            1,400                        $10                       $14,000              $60,000              $10,000 (Scrap Value)
 
Depreciation stops when Book Value is equal to the Scrap Value of the asset. In the end the sum of Accumulated Depreciation and Scrap Value equals to the Original Cost.
[edit]Units of time depreciation
Units of Time Depreciation is similar to units of production, and is used for depreciation equipment used in mine or natural resource exploration, or cases where the amount the asset is used is not linear year to year.
A simple example can be given for construction companies, where some equipment is used only for some specific purpose. Depending on the number of projects, the equipment will be used and depreciation charged accordingly.
Group Depreciation Method :

Group Depreciation method is used for depreciating multiple-asset accounts using straight-line-depreciation method. Assets must be similar in nature and have approximately the same useful lives.
Asset Historical
Cost Salvage
Value Depreciable
Cost Life Depreciation
Per Year
Computers $5,500 $500 $5,000 5 $1,000
Composite Depreciation Method:

The composite method is applied to a collection of assets that are not similar, and have different service lives. For example, computers and printers are not similar, but both are part of the office equipment. Depreciation on all assets is determined by using the straight-line-depreciation method.
Asset Historical
Cost Salvage
Value Depreciable
Cost Life Depreciation
Per Year
Computers $5,500 $500 $5,000 5 $1,000
Printers $1,000 $100 $ 900 3 $ 300
Total $ 6,500 $600 $5,900 4.5 $1,300
Composite life equals the total Depreciable Cost divided by the total Depreciation Per Year. $5,900 / $1,300 = 4.5 years.
Composite Depreciation Rate equals Depreciation Per Year divided by total Historical Cost. $1,300 / $6,500 = 0.20 = 20%
Depreciation Expense equals the composite Depreciation rate times the balance in the asset account. (0.20 * $6,500) $1,300. Debit Depreciation Expense and credit Accumulated Depreciation.
When an asset is sold, debit Cash for the amount received and credit the asset account for its original cost. Debit the difference between the two to Accumulated Depreciation. Under the Composite method no gain or loss is recognized on the sale of an asset.
To calculate Composite Depreciation Rate, divide Depreciation Per Year by total Historical Cost. To calculate Depreciation Expense, multiply the result by the same total Historical Cost. The result, not surprisingly, will equal to the total Depreciation Per Year again.
Common sense requires Depreciation Expense to be equal to total Depreciation Per Year, without first dividing and then multiplying total Depreciation Per Year by the same number. Creators of accounting rules sometimes are very creative, as was noted on the discussion forum of Accounting Coach at
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