What Are the Different Ways to Compute Depreciation?
Depreciation methodically accounts for reductions in the value of a business’s assets over time.
In the United States, accountants must adhere to generally accepted accounting principles (GAAP) in computing and reporting depreciation on financial statements.
GAAP is a set of rules that contain the elements, and legalities of company and corporate accounting. GAAP guidelines highlight many separate valid methods of depreciation that accounting professionals may use.
How the Different Methods of Depreciation Work
There are four treatments for depreciation: straight line, declining balance, sum-of-the-years' digits, and units of production.
Straight-Line Depreciation
The straight-line method defines the estimated salvage value (scrap value) of an asset at the end of its life and then deducts that value from its original cost. The difference is the value that is lost over time during the asset's productive use.
That difference is also the entire amount of depreciation that must be expensed.
Declining Balance Depreciation
The declining balance method is a type of accelerated depreciation used to write off minimization costs more quickly and minimize tax exposure. With the declining balance method, administration expenses depreciate at an accelerated rate rather than evenly over a scheduled number of years. This method is frequently utilized if an asset is expected to have bigger utility in its earlier years. This method also enables to establish a larger realized gain when the asset is sold.
Some businesses may also employ the double-declining balance method, which is an even more aggressive depreciation method for early expense management.
Sum-of-the-Years' Digits Depreciation
The sum-of-the-years' digits method gives a depreciation rate that accelerates more than the straight-line method but less than the declining balance method.
Annual depreciation is divided into fractions utilizing the number of years of the business asset's useful life. Such assets may include buildings, machinery, furniture, equipment, vehicles, and electronics.
To cite an illustration, consider an asset with a useful life of four years, which will have a sum-of-the-years value of 10 ( 4 + 3 + 2 + 1).
The first year is allocated a value of 4, the second year value of 3, and so on.
The depreciation rate for the first year is the straight-line value multiplied by the first year's fraction (4 ÷ 10).
Occasionally called the “SYD” method, this method is moreover more applicable than the straight-line depreciation model if an asset depreciates more quickly or has enormous output capability during its earlier years.
Units of Production Depreciation
Units of production assign a balanced expense rate to each unit generated, which creates it most beneficial for assembly or production lines.
The formula involves using historical costs (the price of an asset based on its nominal or original cost when acquired by the company) and estimated salvage values.
The technique then specifies the expense for the accounting period multiplied by the number of units produced.
Particular Considerations
Overall, businesses have many several choices for depreciating the value of an asset over time. Most businesses use a standard depreciation process for all of the organization’s assets.
Thus, depreciation methodologies are typically industry-specific.
Overview
• Accelerated depreciation is any depreciation method that allows for the recognition of bigger depreciation expenses during the earlier years.
• The key accelerated depreciation methods include double-declining balance and sum of the years’ digits (SYD).
• Companies may utilize accelerated depreciation for tax advantages, as these methods result in a deferment of tax liabilities since income is lower in earlier periods.
• Accelerated depreciation is unlike the straight-line depreciation method, where the latter spreads the depreciation expenses evenly over the life of the asset.
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