Different Types of Depreciation Methods

straight-line depreciation
The straight line method is the simplest method of depreciation in which every year a fixed amount is written off as depreciation from the value of the Asset. 
There are some common factors on which their calculation depends. These factors are listed below.
According to the Diminishing Balance Method, depreciation is charged at a fixed percentage on the book value of the asset. As the book value reduces every year, it is also known as the Reducing Balance Method or Written-down Value Method.

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1. Financial statement Analysis By: Baqir siddique

2. Reduced the value of asset during the particular period of time 2 Depreciation

3. Depreciation Methods 1.Straight line method The straight line method is the simplest method of depreciation in which every year a fixed amount is written off as depreciation from the value of the Asset.  There are some common factors on which their calculation depends. These factors are listed below:

4. 1. Original Cost (or Historical Cost) of the Asset to be depreciated: 4 2. Useful life of the Asset: such as legal or contractual provisions, level of use of the asset, degree of maintenance and technological developments.  3. Estimated residual value or scrap value: It is the value  estimated  to be realised after complete commercial utilisation of a fixed asset.

5. 5 Formula: Depreciation = (Cost – Estimated Salvage value) Estimated useful life Example: Suppose that a Machine costs Rupees 100000 and has an estimated useful life of 8 years and a Salvage value of Rupees 20000. If we follow the straight line method or fixed installment method of depreciation for the machine then the amount to be depreciated every year would be as follows:  = (100000 – 20000)/ 8 = Rs. 10000. Year  Cost  Depreciation  Net Book Value (at the end of the year)                 1        1,00,000               10,000                 90,000                 2            90,000               10,000                 80,000                 3            80,000               10,000                 70,000                 4            70,000               10,000                 60,000                 5            60,000               10,000                 50,000                 6            50,000               10,000                 40,000                 7            40,000               10,000                 30,000                 8            30,000               10,000                 20,000

6. 6 Advantage : 1. Simplest method of deprecation and the calculation is easiest of all other. 2. This method provides for improved comparability since there are no change in rate. 3. Its calculated original cost over the life time. Disadvantage : 1. Its ignore the efficiency of asset which are decrease with the time 2. The amount of depreciation in a function time only 3. Not suitable for machinery items

7. According to the Diminishing Balance Method, depreciation is charged at a fixed percentage on the book value of the asset. As the book value reduces every year, it is also known as the Reducing Balance Method or Written-down Value Method. 2 . Written down value 0r Diminishing Method Formula :

8. 8 Example: year  Cost/WDV  Depreciation @ 10% on WDV  Net Book Value (at the end of the year)                 1        1,00,000               10,000                 90,000                 2            90,000                 9,000                 81,000                 3            81,000                 8,100                 72,900                 4            72,900                 7,290                 65,610                 5            65,610                 6,561                 59,049                 6            59,049                 5,905                 53,144                 7            53,144                 5,314                 47,830                 8            47,830                 4,783                  43,047 Cost = 100,000 Salvage value = 43,047 Year = 8 Depreciation = 10%

9. 9 Advantage : 1 . Under this method, depreciation is calculated according to the net book value of the asset . 2 . This method can be proved very helpful in adopting the better matching of revenue and expenses . 3. Amount of depression reduced with the reducing the balance of asset . Disadvantage : 1. Under this method boo value cannot be zero 2. Not suitable for an asset having a short life . 3. Only suitable for motor vehicles, machines and plant etc

10. 10 3 . Double Declining balance Method This method is a mix of straight line and diminishing balance method. This method applied three steps : Step 1: Straight line rate= 100% / useful life Step 2: Double declining balance rate= 2*straight line rate Step 3: Deprecation expenses= double decline balance rate* beginning period book value Siddique textiles purchased machinery for RS 10,000 on 1st January. It has an estimated useful life of 5 years and an estimated residual value of RS 1,000.  The firm sells the asset at the residual value at the end of the 10th year. The shoes machine has an expected production of 36,000 units during its useful life. Now the production pattern is as follows: Example:

11. 11 Formula: Straight line rate= 100% / 5= 20% Deprecation expenses= double decline balance rate* beginning period book value Step 1: Step 3: year Beginning of period book value Deprecation rate Deprecation Expenses Accumulated depreciation Book value 1 10,000 40% 4,000 4000 6000 2 6,000 40 2,400 6400 3600 3 9,600 40 1,440 7840 3160 4 2,160 40 846 8704 1296 5 1,296 40 296* 9,000 1000 Step 2: Double declining balance rate= 2*20%= 40% Note : 11296-1000= 296 never depreciate book value below salvage value

12. 12 Advantage : 1 . A firm will generate more interest if it invest the depreciation outside the firm . It helps to create more fund at the time of replacement of asset.. 2. The firm will face minimum loss at the time of disposal of asset due to innovation as a large part has already changed to profit and loss account by way of depreciation. Disadvantage : 1 . This method shows lower profit in the earlier year as high depreciation is charged . It will show poor performance in the initial year. 2 . The investors are unhappy as they get low dividend in the earlier year for generating lower profit by the firm. 3. they face high cost of production due to higher depreciation.

13. 13 This method of charging depreciation  on the asset is based on the units produced during the year. The estimated total production of the asset is the criteria for providing depreciation. Assets on which this method can be applied are Plant and Machinery. As their wear and tear will depend on how much we use them. 4 . Units of Production Method

14. 14 Formula: Depreciation per unit = Cost- Salvage value Total units of production Step 1: Step 2: Deprecation Expense = Depreciation per unit * units of produced in period Example: Siddique textiles purchased machinery for RS 10,000 on 1st January. It has an estimated useful life of 5 years and an estimated residual value of RS 1,000.  The firm sells the asset at the residual value at the end of the 10th year. The shoes machine has an expected production of 36,000 units during its useful life. Now the production pattern is as follows: Year Production Year production 1 7000 units per year 4 7000 units 2 8000 units per year 5 5000units 3 9000 units per year

15. 15 Depreciation per unit = 10,000-1,000 36,000 units =0.25 per unit Deprecation Expense= 0.25 per unit * 7,000 units in first year = 1750 Year No of Units Depreciation per unit Depreciation Expense Accumulated depreciation Book value 1 7,000 0.25 per unit 1750 1750 8250 2 8,000 0.25 2,000 3750 6250 3 9,000 0.25 2,250 6,000 4000 4 7,000 0.25 1,750 7,750 2250 5 5,000 0.25 12,50 9,000 1000

16. 16 Advantage : This method is based on no of units of production . When the productivity of low and deprecation is also low. Disadvantage : Only suitable for production items machines.

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