# Depreciation

Depreciation is calculating the asset’s cost to expense over the accounting periods that the asset is likely to be used. For Example, if a business purchases a delivery truck at the cost of 100,000 and it is expected to be used for 5 years, the business might have depreciation expense is 20,000 in each of the five years. The above example notifies each year there will be adjusting entry with a debit to Depreciation Expense for 20,000 and a credit to Accumulated Depreciation for 20,000. Since the adjusting entries do not involve cash so depreciation expense is referred to as a noncash expense.

There are three methods to calculate the Depreciation in small businesses. They are

- Straight line method
- Unit of production method
- Double-declining balance method

__Straight line method:__

It’s the simplest method of all and It involves simple allocation of an even rate of depreciation every year over the useful life of the asset. The formula for straight-line depreciation is:

Annual Depreciation expense = (Asset cost–Residual Value) / Useful life of the asset

Example – Suppose a manufacturing company purchases a machinery for Rs. 100,000 and the useful life of the machinery are 10 years and the residual value of the machinery is Rs. 20,000

Annual Depreciation expense = (100,000-20,000) / 10 = Rs. 8,000

Therefore the company can take Rs. 8000 as the depreciation expense every year

__Unit of production method:__

This Method is a two-step process, unlike straight-line method. In this, the calculation is based on output capability of the asset rather than the number of years.

Step 1: Calculate per unit depreciation:

Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of production

Step 2: Calculate the total depreciation of actual units produced:

Total Depreciation Expense = Per Unit Depreciation * Units Produced

Example: ABC company purchases a printing press to print flyers for Rs. 40,000 with a useful life of 1,80,000 units and residual value of Rs. 4000. It prints 4000 flyers.

Step 1: Per unit Dep. = (40,000-4000)/180,000 = Rs. 0.2

Step 2: Total Dep. expense = Rs. 0.2 * 4000 flyers = Rs. 800

Hence the total Dep. expense is Rs. 800 which is accounted. Once the per unit depreciation is found out, it can be applied to future output runs.

__Double-declining balance method __

This is an accelerated depreciation (Dep.) method. As the name suggests, it counts expense twice as much as the book value of the asset every year.

The formula is:

Dep. = 2 * Straight line depreciation percent * book value at the beginning of the accounting period

Book value = Cost of the asset – accumulated depreciation

Accumulated Dep.is the total depreciation of the fixed asset accumulated up to a specified time.

Example: On April 1, 2012, company X purchased an equipment for Rs. 100,000. This is expected to have 5 useful life years. The salvage value is Rs. 14,000. Company X considers depreciation expense for the nearest whole month. Calculate the Depreciation(Dep.) expenses for 2012, 2013, 2014 using declining balance method.Useful life = 5

.

Straight line Dep. percent = 1/5 = 0.2 or 20% per year

Dep. rate = 20% * 2 = 40% per year

Dep.for the year 2012 = Rs. 100,000 * 40% * 9/12 = Rs. 30,000

Dep. for the year 2013 = (Rs. 100,000-Rs. 30,000) * 40% * 12/12 = Rs. 28,000

Dep. for the year 2014 = (Rs. 100,000 – Rs. 30,000 – Rs. 28,000) * 40% * 9/12 = Rs. 16,800