Depreciation Methods
In order to calculate depreciation, we first must know the asset’s (1) Cost, (2) Estimated useful life and (3) Estimated residual value. Cost is the purchase price to acquire the asset. Estimated useful life is the length of service the business expects to get from the asset—an estimate of how long the asset will be useful. Useful life may be expressed in years, units of output, miles, or another measure. Estimated residual value—also called scrap value or salvage value—is the expected cash value of an asset at the end of its useful life. The full cost of a plant asset is depreciated if the asset is expected to have no residual value. The plant asset’s cost minus its estimated residual value is called the depreciable cost.
There are four methods in computing depreciation: (1) straight-line, (2) units-of-production, (3) declining-balance, and (4) sum-of-years’-digits. These four methods allocate different amounts of depreciation expense to each period. However, they all result in the same total amount of depreciation, the asset’s depreciable cost over the live of the asset.
Straight-Line Method
When the straight-line method is used to allocate depreciation, the depreciable cost of the asset is spread evenly over the estimated useful life of the asset. The straight-line method is based on the assumption that depreciation depends only on the passage of time. The depreciation expense for each period is computed by dividing the depreciable cost (cost of the depreciating asset less its estimated residual value) by the number of accounting periods in the asset’s estimated useful life. The rate of depreciation is the same for each period.
Production Method
The production method of depreciation is based on the assumption that depreciation is solely the result of use and that the passage of time plays no role in the depreciation process. The depreciation expense for each unit of production is computed by dividing the depreciable cost (cost of the depreciating asset less its estimated residual value) by the number of estimated units of useful life of the asset.
Double-Declining-Balance Method
The double-declining-balance method is an accelerated method of depreciation is computed by applying a fixed rate to the carrying value (the declining balance) of a long-lived asset. The percentage used is for the depreciation rate is twice the straight-line rate.
Sum-of-the-Years’-Digits Method
The sum-of-the-years’-digits method is an accelerated method of depreciation in which the years in the service live of an asset are added. Their sum becomes the denominator of a series of fractions that are applied against the depreciable cost of the asset in allocating the total depreciation over the estimated useful life. The numerators of the fractions are the individual years in the estimated useful of the asset in their reverse order. The denominator used in the sum-of-the-years’-digits method can be computed quickly by using the following formula:
Example of the Computation of Depreciation
Let us compare the four methods of depreciation by computing the depreciation expense and the carrying cost of an asset by using the four methods listed above.
| Asset | Truck |
|---|---|
| Cost | $10,000 |
| Salvage Value | $1,000 |
| Estimated Useful life (years) | 5 |
| Estimated Units of Useful life (miles) | 90,000 |
| Year 1 miles | 20,000 |
| Year 2 miles | 30,000 |
| Year 3 miles | 10,000 |
| Year 4 miles | 20,000 |
| Year 5 miles | 10,000 |
| Total miles driven | 90,000 |
Depreciation Schedule, Straight-Line Method
| Cost | Miles | Yearly |
Accumulated Depreciation |
Carrying Value |
|
|---|---|---|---|---|---|
| Date of purchase | 10,000 | --- | --- | --- | 10,000 |
| End of first year | 10,000 | 20,000 | 1,800 | 1,800 | 8,200 |
| End of second year | 10,000 | 30,000 | 1,800 | 3,600 | 6,400 |
| End of third year | 10,000 | 10,000 | 1,800 | 5,400 | 4,600 |
| End of fourth year | 10,000 | 20,000 | 1,800 | 7,200 | 2,800 |
| End of fifth year | 10,000 | 10,000 | 1,800 | 9,000 | 1,000 |
Depreciation Schedule, Production Method
| Cost | Miles | Yearly |
Accumulated Depreciation |
Carrying Value |
|
|---|---|---|---|---|---|
| Date of purchase | 10,000 | --- | --- | --- | 10,000 |
| End of first year | 10,000 | 20,000 | 2,000 | 2,000 | 8,000 |
| End of second year | 10,000 | 30,000 | 3,000 | 5,000 | 5,000 |
| End of third year | 10,000 | 10,000 | 1,000 | 6,000 | 4,000 |
| End of fourth year | 10,000 | 20,000 | 2,000 | 8,000 | 2,000 |
| End of fifth year | 10,000 | 10,000 | 1,000 | 9,000 | 1,000 |
Depreciation Schedule, Double-Declining-Balance
| Cost | Miles | Yearly |
Accumulated Depreciation |
Carrying Value |
|
|---|---|---|---|---|---|
| Date of purchase | 10,000 | --- | --- | --- | 10,000 |
| End of first year | 10,000 | 20,000 | 4,000 | 4,000 | 6,000 |
| End of second year | 10,000 | 30,000 | 2,400 | 6,400 | 3,600 |
| End of third year | 10,000 | 10,000 | 1,440 | 7,840 | 2,160 |
| End of fourth year | 10,000 | 20,000 | 864 | 8,704 | 1,296 |
| End of fifth year | 10,000 | 10,000 | 296 | 9,000 | 1,000 |
Depreciation Schedule, Sum-of-the-Years'-Digits
| Cost | Miles | Yearly |
Accumulated Depreciation |
Carrying Value |
|
|---|---|---|---|---|---|
| Date of purchase | 10,000 | --- | --- | --- | 10,000 |
| End of first year | 10,000 | 20,000 | 3,000 | 3,000 | 7,000 |
| End of second year | 10,000 | 30,000 | 2,400 | 5,400 | 4,600 |
| End of third year | 10,000 | 10,000 | 1,800 | 7,200 | 2,800 |
| End of fourth year | 10,000 | 20,000 | 1,200 | 8,400 | 1,600 |
| End of fifth year | 10,000 | 10,000 | 600 | 9,000 | 1,000 |