Depreciation methods allow companies and individuals to show how much value their assets lose over a certain amount of time. You may choose from various different depreciation methods to show the depreciation in value for fixed (non-current) and current assets. The type of method you use depends on your company's needs, your financial situation and the way in which you use your assets.
Straight Line Method
The straight line method is very simple, so Internal Revenue Service recommends it. To determine how much depreciation a specific asset will have with this method, divide the cost of the asset evenly over its years of life. To use this method, you need to know how much you paid for the asset, the asset's useful life, or how long it will be in use to establish the salvage value for the asset. Salvage value is the value of the asset at the end of its life. You determine it through analyzing how much your asset is likely to cost at the end of its life. Once you have this information, divide the difference between the cost of the asset and its salvage value by the asset's span of useful life. Apply the result of this calculation to each year of depreciation for the asset's life.
Declining Balance Method
The declining balance method is an accelerated depreciation method. Accelerated depreciation means that it calculates more depreciation for the asset's first few years of life than simpler methods such as the straight line method. Use this method if you want to show more depreciation in the first years. To calculate depreciation with this method, first determine the rate of depreciation. Divide 1 by the asset's useful life and multiply the result by 1.5, or 2 if you prefer the double declining balance method, which gives you an even higher depreciation. This result is your depreciation rate. Every year, multiply the book value of the asset--the cost of the asset minus the accumulated depreciation, which is zero for the first year--by the depreciation rate. The result is what you deduct from your asset's total cost. "Publication 946," an IRS document, recommends the use of this method for long-term properties.
The sum-of-the-years'-digits method is another accelerated method of calculating depreciation. However, the depreciation of the first years is even larger than in the declining balance method. To calculate depreciation with this method, find the depreciation fraction, which is the asset's total years of life still left divided by the sum of all the years. For example, if the asset's life is four years, divide the years still left by the following sum: 1+2+3+4. The general formula for the sum of the year is 1+2+3+4+...+n, where "n" is the asset's total life. Multiply the value of the fraction of each year by the difference between the cost of the asset and its salvage value. The result you get each year is the depreciation for that year.
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