How do I Calculate Depreciation

How do I calculate depreciation? Depreciation is used in accounts to reduce the value of a fixed asset over several years. There are several different methods of depreciation that a business can use; once you have chosen your method for a type of asset, you will need to use the same method each time.

If you have several different types of assets you will need to look at the method to use for each one. It might be that the straight-line method works for some, but the declining balance method is best for others.

In this article, we will look at the depreciation methods, examples and how to post them to the accounts.

What depreciation methods are there?

The are several different methods of calculating depreciation and we will look at each one in detail.

• Straight-line depreciation – An equal figure is posted in each period over the lifetime of the asset. Example: A business buys a new computer for £300, which will be depreciated over 3 years. Each year the company will show £100 (£8.33 per month) in the accounts.
• Declining Balance or Reducing Balance – The depreciation is higher in the early stages of the assets life and then reduces over time. This method is usually used for cars, which depreciate very fast in the early stages of ownership.
• Double declining balance method – The assets reduce even faster at the earlier stages of depreciation. It uses double the percentage in the straight-line method.
• Sum of the Years Digits – Accelerates depreciation in the early years, and uses the number of years to calculate depreciation.
• Units of Production – This is mainly used for machinery producing a product. It spreads the cost over the years based on usage.

Depreciation Keywords

Here are a few of the keywords used in this article:

Accumulated depreciation – The total depreciation of the asset is posted on the balance sheet.

Cost of an asset – The original purchase price of the asset is posted on the balance sheet.

Depreciation Expense – The amount of depreciation posted to the profit and loss account as an expense.

Fixed Asset – If the business purchases an item, which is expected to have a useful life of more than one year, it is an asset.

Fixed Asset Register – A log of all the assets including serial numbers, description, value and location.

Net Book Value – The value of the asset in the balance sheet. Cost of the asset minus depreciation.

Salvage Value – The resell value at the end of the useful life of the asset. Some assets will not have a resale value at the end.

Useful life – It is the number of years you expect the asset to be used, it will vary from asset to asset. A computer might be expected to have a useful life of 2-3 years, while office furniture 7-10.

Straight-Line Depreciation Method

Straight-line depreciation is seen as one of the easiest methods to use. It is worked out by taking the cost value of the asset and taking away the salvage value.

The remaining balance is then divided equally between the number of months the asset is depreciated for. Here are a couple of examples for the straight-line method.

A company purchases a desk for 500, the useful life is estimated at 7 years, at the end of its useful life it is expected to have no salvage value. The formula is:

500 / 7 x 12 = 500 / 84 = 5.95 per month or 71.40 per year.

Our second example is for a computer purchased at 350, a useful life of 3 years and salvage of 50.

374 – 50 / 36 = 324 / 36 = 9 per month or 108 per year

If you are using straight-line depreciation take a look at our free excel template to help schedule the depreciation. Full instructions are provided, it allows you to list all the assets, when they are purchased, asset value and number of years for its useful life. This information will calculate the depreciation per year for all the assets.

Declining Balance Method

The declining balance method, also know as the reducing balance method, assumes that the asset will decline more in the early years of life than in the later years. It is accelerated depreciation, therefore, writes of the value of the asset at a higher value when it is new. An example is if a car is purchased, as soon as it is on the road it loses a higher value than at the end of its life.

Using the example of a company purchasing a car at £20,000, they expect it to have an annual depreciation rate of 40%.

The figures are as follows:

The depreciation for each year is 8000, 4800, 2880, 1728 and 1036.8 – so each year accounting for depreciation is less.

Double declining Balance Method

The double-declining balance (DDB) method is also accelerated depreciation and will therefore depreciate more in the early years. The formula above it doubles (x2) the straight-line depreciation method.

An example of DDB is a company that purchased a van for £30,000 which is the cost of the asset. They expect the asset to have a useful value of 7 years. At the end of the 7 years, the remaining balance will be the net book value or salvage value.

We will show you the calculation for the first 2 years using 15% doubled so 30%:

Year 1 – current book value 30,000 x 30% = 9000 New value 30,000 – 9000 = 21,000.

Year 2 – 21,000 x 30% = 6300 New value 21,000- 63000 = 14,700.

Sum of Years Digits

The sum of years digits uses the number of years to calculate the value. The best way to understand the method is to look at a working example. A small business purchases a truck for £100,000 and has a salvage value of £10,000 with a useful life of 5 years.

The sum of years digits is 5 + 4 + 3 + 2 + 1 =15

In year 1 it has 5 years of remaining life (you take the figure at the beginning of the year), therefore the formula is

90,000 x (5 / 15) = 30,000

Year 2

90,000 x (4 / 15) = 24,000

The table below shows all 5 years.

Units of Production

This method is mainly used for machinery used to produce a product. To calculate the depreciation you will need to know how many products you expect to create over the useful life.

Below is an example of a piece of machinery purchased at £150,000, it has a salvage value of 30,000, useful life of 5 years and is expected to manufacture 100,000 products.

In the first year the calculation for 25,000 units is as follows:

150,000 (asset cost) – 30,000 (salvage Value) / 100,000 (expect units produced) = 1.2 (production rate). In year 1 – 25,000 units at 1.2 = 30,000 depreciation.

Depreciation Calculators

We have produced two depreciation calculators, straight line and reducing balance. These calculators are great to see how much your asset will depreciate over time. Use our depreciation calculators.

How long should I depreciate an item for?

The length you depreciate an asset for will depend on the type of item and its useful life. A car can be the estimated length of time you expect to own it, computers typically have a life span of 2-3 years, but items like furniture and machinery you will want to spread over a longer period.

If you are unsure, it is worth seeking advice from your accountant; they can generally inform you of the best method, the asset’s useful life and period to use.

How is depreciation shown in the accounts?

When an asset is purchased by a business the value of an asset is posted to the balance sheet. The double entry is from the source purchase. It might be a bank account or credit card.

Each period value is posted to the accumulated depreciation account on the Balance sheet and an expense on the Profit and Loss Account.

An example of posting to the accounts is that a company purchases a computer at the beginning of the financial year for 600 by bank transfer. The initial opening transaction is

• Credit Bank – 600
• Debit Asset – 600

At the end of year 1, the computer is expected to have a useful life of 3 years.

Each year a journal is created for the depreciation expense.

At the end of the first year, the accounts will show an asset value of 600-200 = 400

Take a look at the depreciation accounting section to find further information on the different methods and a free calculator.

What Is Accumulated Depreciation?

Accumulated depreciation is the total of the depreciation over several years and is found on the balance sheet.

here is an example of accumulated depreciation

A small business purchases a computer for 300.00 and will depreciate it over three years using the straight-line method.

Each year 100.00 will post to the depreciation expense on the profit and loss account and 100 to accumulated depreciation on the balance sheet.

After two years, the balance sheet will show 300.00 Assets and 200.00 accumulated depreciation. It will leave a balance of 100.00 on the asset for the third year.

Summary of How do I Calculate Depreciation

• Choose the best method of depreciation and always use it. The choice is between the straight-line method, declining balance and double-declining balance.
• Decide how many years to depreciate over, this is its useful life.
• Calculate the depreciation
• Post the figures to the accounts

Further information on how do I calculate depreciation is available on the balance website