How to calculate depreciation expense
In business at times we tend to have assets such machineries, equipment etc. that are always going to depreciate in value over a period of time. Finance managers and the accounting department must always know the value of the different assets that their organization holds. The calculation of depreciation expense is a very important part of financial reporting. It helps to show how valuable your assets are. This will help you to make important decisions such as buying new equipment, calculating the expense against income and the effect it will have on your business etc.
You have different techniques you can use to calculate the depreciation expense of fixed tangible assets. You also have different methods for different circumstances. Keep in mind that once a method is selected. You must consistently use it in all your financial reports in order to get the true value of an asset over a period of time.
You have two types of methods that are going to be discussed below, the straight-line method and reduce balance method.
These are two of the most popular methods and they are also pretty easy to implement on How to Calculate Depreciation Expense:
Straight line method
For this method an instalment or fixed proportion of the original capital is provided equally in each accounting period. Each year the value of the asset in this method is always being reduced according to its scrap value throughout to end of its life. The fixed amount can then be charged to the revenue account.
For example you have a machine which cost $10,000 and it will have a life value of 10 years. The cost divided by the number of years will show the amount of depreciation that must be written off when accounting time comes. Using this method the annual appreciation value would be $1000. If you should take the scrap value into account and the scrap value is $1,500.
The total loss of depreciation would be $8,500 and your annual loss would be $850.
As you can see this is a very simple method. Persons also tend to prefer this one to use over the years due to its simplicity.
Reduce balancing method
This technique is entirely based off of the fixed percentage of the value of the asset as reduce by previous provisions. When you use this method it will give you a fairly even charge against income every year. So for example you just bought a new equipment. The depreciation of the fixed asset is going to probably be heavier in this period when the repairs and maintenance are cheap. Throughout its lifecycle closely to the end the depreciation will fall. When the repairs and maintenance got more expensive and this will force you to get a new one.
Here is a quick example; you just bought a new machine for $5,000. Suppose you set your depreciation rate to 10%. It must look something like this.
Cost price $5000
1st year: depreciation rate 10% $500
= $4,500
2nd year: depreciation rate 10% $500
= $4,000
This will continue until it’s done. In summary both methods shown above can be very useful methods. You can use in your organization to calculate your depreciation expense.
Along with those two you have other methods as well such as sinking fund method, production unit method, annuity system, valuation method, insurance policy method etc. Some of these methods serve different purposes but they all share the same goal.