Methods of Depreciation by mikeholy


									Methods of Depreciation

1)   Straight-Line

     •    assumes that the asset will contribute to earning revenue
          equally during each period
     •    depreciation expense is the same for every year of the
          asset’s useful life
     •    Annual Expense:          Cost - Salvage Value
                                   Estimated Useful Life

2)   Units of Output

     •    an equal amount of depreciation is charged for each unit
     •    appropriate when the amount of use of an asset varies
          from period to period
     •    suitable only when units of output over asset’s entire
          useful life can be estimated with reasonable accuracy
     •    Annual Expense: Cost - Salvage Value          * # of units
                              Number of Units of          produced
                              Estimated Productive Life
3)        Accelerated Depreciation

              recognition of relatively large amounts of depreciation in
               early years and less in later years
              assets more efficient and provide better services earlier
              therefore should allocate greater portion of asset’s cost to
               match this greater output
              popular for tax purposes – reduces tax burden in current

              there are two varying techniques of accelerated

     a)   Double-Declining Balance

          •    double straight-line depreciation rate
          •    this constant rate is applied to the Net Book Value
               (NBV) of the asset to determine the amount of
               depreciation for the period (NBV = Cost - Accumulated
          •    continue depreciating until the NBV = Salvage Value
          •    Annual Expense = NBV * constant rate

     b)   Sum-of-Years’ Digits (SYD)

              depreciation rate to be used is a fraction
              the numerator is remaining years of useful life
              the denominator = sum of years of useful life
          •    Annual Expense:
               (Cost -            *      useful life at beginning of period
                Salvage Value)             sum of the years of useful life
Partial Year Depreciation

•    in the year of acquisition, the amount of depreciation must be
     apportioned according to the length of time the asset has actually been

•    if the purchase was made during the first half of the month, include
     that month in your depreciation calculation

•    if the purchase was made during the last half of the month, do not
     include that month in your depreciation calculation

•    partial depreciation must also be calculated when asset disposal

•    the half-year rule requires that in the year of acquisition, only a ½
     year of depreciation may be taken, regardless of the purchase date

Depreciation’s Impact on Financial Statements

•    the choice of depreciation method will have an impact on the income

•    using an accelerated method of depreciation (SYD, declining balance)
     results in a lower net income figure initially and then a higher net
     income figure near the end of its useful life

•    GAAP requires the consistent application of one depreciation method
     (consistency principle)

•    but, the same method is not required for different types of plant assets

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