4 Methods of Calculating Depreciation Expense Explained

Posted by Southwest Beverages on 2/17/2015
All tangible assets (also known as capital assets) of the company are assets employed by the business to generate current or future revenues of the company. As such the assets historical cost (unexpired cost) must be spread out over its useful life to match the revenue which it will produce. Accordingly, depreciation expense is an expired cost and as such is recorded as an operating expense of the business which reduces the company’s net income; correspondingly it will reduce the fixed assets of the company by the same amount. There are 4 methods of calculating depreciation expense: The straight line method, the double declining balance method, the sum of the year’s digits method and the units of production method.

1. Straight Line Method

The straight line method of commuting depreciation expense is the simplest and most common method used. The periodic depreciation amount is calculated by using the following formula:

Assets historical cost less estimated salvage value
Estimated useful life of the asset

Concept Illustrated:
Assume: Asset Value=                                   \$100,000
Assume: Scrape Value=                                 \$  10,000
Value to be depreciated=                             \$  90,000
Assume: Estimated economic useful life=       5 years
Depr. Expense for the period-straight line=  \$ 18,000
% of asset being depreciated                            20 %

2. Double Declining Method

Also known as the “Accelerated” method, the double declining method calculates the period’s depreciation expense by simply doubling the percentage used under the straight line method for each period until such time as the resulting depreciation expense for the period is less than that periods depreciation expense derived using the straight line method. When this occurs, the amount of depreciation expense recorded for that period will be the remaining book value divided by the number of periods remaining (the straight line method).

Concept Illustrated:

Double straight line method period depr. %        40 %

Year 1 beginning of year asset value             \$100,000
Year 1 depr. expense (\$100,000 x 40 %)         \$  40,000
Year 1 ending book balance                          \$  60,000

Year 2 depr. expense (\$60,000 x 40 %)           \$  24,000
Year 2 ending book balance                           \$  36,000

Year 3 depr. expense (\$36,000 x 40 %)           \$  14,400
Year 3 ending book balance                           \$  21,600

Year 4 depr. expense (\$21,600 x 40 %)          \$    8,640
Year 4 ending book balance                          \$  12,960
Less salvage value                                       (\$  10,000)
Year 5 depreciation expense                        \$   2,960

The double declining method is mostly used by tax accountants to reduce (or accelerate) the amount of depreciation expense their client can record on their income statement, which translates to additional profits.

3. Sum of the Years Digits Method

As the name implies this method of calculating the period’s depreciation expense is determined simply by adding up the years of the assets estimated useful life. For example if an asset is determined to have an estimated useful life of 5 years, a 33 % rate would be applied to the assets beginning book value to arrive at the period’s depreciation expense.

Concept Illustrated:

Year 1:     5/15 or 33.33 %
Year 2:     4/15 or 26.67 %
Year 3:     3/15 or 20.00 %
Year 4:     2/15 or 13.33 %
Year 5:     1/15 or   6.67 %

4. Units-of-Production Method

As the name implies this method of calculating the period’s depreciation expense involves calculating a per unit deprecation rate and then multiplying that rate by the actual number of units produced during the period. Depreciation expense for the period can be calculated using the following formula:

Original asset cost less salvage value/Total units of production
X
Units produced during the period

Written by Bob Jenkins, Founder & Chief Executive Officer of Southwest Beverages®

Bob has had the privilege of working for some of America’s largest and well run public and private companies, including Philip Morris, Canada Dry, Dr Pepper, Cadbury Schweppes, Snapple Beverage Corporation, Tasker Capital Corp. and The Water Club and River Cafe – two of New York’s finest fine dining restaurants. He has worked in various capacities as Finance Manager, Controller, Director of Finance, Vice President Finance & Administration, Chief Financial Officer, Secretary, and Treasurer.

Bob holds a Masters of Business Administration degree in accounting from the University of Tennessee and a Bachelor of Science degree in accounting from the University of Arizona.

Southwest Beverages® is a manufacturer and marketer of two brands of premium quality dry mix beverages: Sippity® hot cocoa mix and Kemosabe® gourmet flavored coffee. All Southwest Beverages® products are uniquely blended flavors that contain all the ingredients necessary for you to enjoy the ultimate hot beverage experience. Simply add water and stir-then sip, savor and enjoy.

Interested in writing a guest blog for Southwest Beverages®? Send your topic idea to pr@southwestbeverages.com.

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