What Is Depreciation and How Do You Calculate It?
Depreciation is a term that gets defined as the decrease in the actual cost of assets, which gets fixed systematically until the value of the asset becomes
negligible. The reduction in the value happens due to various reasons, and one among these reasons is unfavorable market conditions. Some of the assets whose value is likely to reduce are the value of the currency or equipment or any machinery, buildings, office equipment, furniture, etc.
This process is essential during the taxation purpose, such as property tax, etc. The land is the only thing whose value never depreciates, but instead, the value appreciates with time. The depreciation calculation will help you in determining the value of the fixed asset.
Example of Depreciation
Suppose if a company is purchasing a delivery truck for $100,000 and suppose expected usage of the vehicle is for five years, then the company needs to pay a depreciation amount of $20,000 for over five years.
Information Required to Calculate Depreciation
The Useful Life of the Fixed Asset
Based on the type of asset, the period is determined. The accountant will probably help you in knowing about the exact period of the asset.
The Salvage Value Needs To Get Deducted
At the end of the useful life, the salvage value undergoes deduction from the total amount. The account will also help you in determining the salvage value of the item.
Divide with the Cost of the Asset
The value of the asset includes the extra expenses, which provides for all the costs of acquiring the product, such as the transportation cost, the price used in training the people to use the equipment, setup cost, etc.
All these values will get entered into the book value of the asset.
About Accumulated Depreciation
Accumulated depreciated is the value which is calculated cumulatively at a single point of time. The difference between the accumulated depreciation and the purchase price is the carrying value of an asset.
An organization purchases and holds an asset for that period for which the salvage value must be equal to the carrying value. The assets which get capitalized, which means accountants apply the cost for more than one year.
Experts term this value as accumulated depreciation. The total amount which gets depreciated over the asset life is the actual value of the accumulated depreciation.
Different Methods of Calculating Depreciation
It is essential to know about the various methods of calculating depression. Some of these methods include:
Straight-Line Depreciation Method
This method is known to be the simplest method of calculating depreciation. If you wish to find the depreciation amount of the property, the most important thing is you need to determine the depreciation value at an equal amount for every year over its useful life span. You can use this formula for calculating annual depreciation –
Annual depreciation= Remaining book value x depreciation factor x 1 / lifespan.
Declining Balance Method
In this method, you will be able to determine most of the asset value in the early stage of the equipment’s lifespan. There are mostly two ways in this method, which are the 150% declining balance method and the double-declining balance method.
The depreciation value keeps on changing, so it’s become more complicated when you start with the calculation. The formula for calculating the depreciation value with the double-declining balance method is
Annual Depreciation = Remaining book value x depreciation factor x 1 / lifespan
The Sum of the Year’s Digits (SYD) Method
In this method, the expected life of the asset is an essential factor. It is added together along with digits of each year, known as the ‘sum of the years’ digits’ method. It is one of the accelerated ways of determining depreciation value. Here is the formula for calculating the number of years’ figures.
Depreciation expense = depreciable cost x remaining useful life of the asset/sum of the years’ digits.
Example of SYD Method
Suppose if the asset can last for say four years, the sum of the years’ digit gets calculated as 4 + 3 + 2 + 1 =10. Each of the numbers is then divided by the amount so that the percentage can be finding out for which the asset needs to get depreciated.
If you wish to keep the accounting records properly, depreciation is an important thing that needs to get calculated. That will help in maintaining the income statement and also the balance sheet appropriately along with the profits.
There are a lot of business accounting software programs that will also help you to determine the depreciation value by eliminating the errors. It will help in creating invoices, tracking the expenses as well as calculating the taxes as well in a proper way