Accounting for depreciation is a vital procedure for companies. This way, they are able to record their assets at their current market values. The value that the asset would fetch in the market if it were to be sold today is its current market value. The diminishing method of calculating depreciation is a useful and commonly used tool. With this method, the company tries to write off most of the reduction in value during the asset's initial years.
When the company acquires an asset, it decides on the rate at which it would depreciate the asset and its estimated useful life. The estimated useful life is the number of years the company assumes the asset is likely to be productive.
At the end of each year, the book value of the asset is multiplied by the rate of depreciation. For example, at the end of the first year, the price at which the asset was bought is multiplied by the rate of depreciation to calculate the depreciation amount for the first year.
At the end of each year, the calculated depreciation amount is subtracted from the asset's value at the beginning of the year to arrive at the asset's book value at the end of the year. For example, if the asset's book value at the beginning of the year was $1,000 and the amount of depreciation is $200, the asset's book value at the end of the year would be $800 ($1,000 - $200).
The corresponding entries for the reduction in the value of the asset are made in all of the company's financial statements. The value of the asset is reduced in the balance sheet. The depreciation expense is noted in the income and expenditure statement. And the asset's account also shows the depreciation entry.