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Depreciation Methods


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GAAP

     Depreciation is a systematic and rational process of distributing the cost of tangible assets over the life of assets.
     Depreciation is a process of allocation.
     Cost to be allocated = acquisition cot - salvage value
     Allocated over the estimated useful life of assets.
     Allocation method should be systematic and rational.

 

Depreciation Methods


    Depreciation methods based on time
           Straight line method
           Declining balance method          
           Sum-of-the-years'-digits method

    Depreciation based on use (activity)

 
 

Straight Line Depreciation Method


    Depreciation = (Cost - Residual value) / Useful life

[Example, Straight line depreciation] 

       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using straight line depreciation method.  

       Depreciation for 2011
           = ($140,000 - $20,000) x 1/5 x 9/12 = $18,000

       Depreciation for 2012
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

       Depreciation for 2013
           = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000



Declining Balance Depreciation Method


    Depreciation = Book value x Depreciation rate
       Book value = Cost - Accumulated depreciation
       
       Depreciation rate for double declining balance method
           = Straight line depreciation rate x 200%

       Depreciation rate for 150% declining balance method
           = Straight line depreciation rate x 150%

[Example, Double declining balance depreciation] 
 
       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using double declining balance depreciation method.  

       Useful life = 5 years  -->  Straight line depreciation rate = 1/5 = 20% per year

       Depreciation rate for double declining balance method 
            = 20% x 200% = 20% x 2 = 40% per year

       Depreciation for 2011
           = $140,000 x 40% x 9/12 = $42,000

       Depreciation for 2012
           = ($140,000 - $42,000) x 40% x 12/12 = $39,200

       Depreciation for 2013
           = ($140,000 - $42,000 - $39,200) x 40% x 12/12 = $23,520

 
   Double Declining Balance Depreciation Method
 
Year Book Value
at the beginning
Depreciation Rate Depreciation Expense Book Value at the year-end
2011 $140,000 40% $42,000 (*1) $98,000
2012 $98,000 40% $39,200 (*2) $58,800
2013 $58,800 40% $23,520 (*3) $35,280
2014 $35,280 40% $14,112 (*4) $21,168
2015 $21,168 40% $1,168 (*5) $20,000

   (*1) $140,000 x 40% x 9/12 = $42,000
   (*2) $98,000 x 40% x 12/12 = $39,200
   (*3) $58,800 x 40% x 12/12 = $23,520
   (*4) $35,280 x 40% x 12/12 = $14,112
   (*5) $21,168 x 40% x 12/12 = $8,467 
 
           --> Depreciation for 2015 is $1,168 to keep book value same as salvage value.
           --> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)

 

[Example, 150% declining balance depreciation]
  
       On April 1, 2011, Company A purchased an equipment at the cost of $140,000.  This equipment is estimated to have 5 year useful life.  At the end of the 5th year, the salvage value (residual value) will be $20,000.  Company A recognizes depreciation to the nearest whole month.  Calculate the depreciation expenses for 2011,  2012 and 2013 using double declining balance depreciation method.  

       Useful life = 5 years  -->  Straight line depreciation rate = 1/5 = 20% per year

       Depreciation rate for double declining balance method 
            = 20% x 150% = 20% x 1.5 = 30% per year

       Depreciation for 2011
           = $140,000 x 30% x 9/12 = $31,500

       Depreciation for 2012
           = ($140,000 - $31,500) x 30% x 12/12 = $32,550

       Depreciation for 2013
           = ($140,000 - $31,500 - $32,550) x 30% x 12/12 = $22,785


   150% Declining Balance Depreciation Method
 
Year Book Value
at the beginning
Depreciation Rate Depreciation Expense Book Value at the year-end
2011 $140,000 30% $31,500 (*1) $108,500
2012 $108,500 30% $32,550 (*2) $75,950
2013 $75.950 30% $22,785 (*3) $53,165
2014 $53,165 30% $15,950 (*4) $37,216
2015 $37,216 30% $11,165 (*5) $26,051
2016 $26,051 30% $6,051 (*6) $20,000

   (*1) $140,000 x 30% x 9/12 = $31,500
   (*2) $108,500 x 30% x 12/12 = $32,550
   (*3) $75,950 x 30% x 12/12 = $22,785
   (*4) $53,165 x 30% x 12/12 = $15,950
   (*5) $37,216 x 30% x 12/12 = $11,165 
   (*6) $26,051 x 30% x 12/12 = $7,815 
 
           --> Depreciation for 2016 is $6,051 to keep book value same as salvage value.
           --> $26,051 - $20,000 = $6,051 (At this point, depreciation stops.)



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Sum-of-the-years'-digits method

    
    Depreciation expense = (Cost - Salvage value) x Fraction
         Fraction for the first year = n / (1+2+3+...+ n)
         Fraction for the second year = (n-1) / (1+2+3+...+ n)
         Fraction for the third year = (n-2) / (1+2+3+...+ n)
           ...
         Fraction for the last year = 1 / (1+2+3+...+ n)

         n represents the number of years for useful life.
 

[Example, Sum-of-the-years-digits method]

  Company A purchased the following asset on January 1, 2011. 
   What is the amount of depreciation expense for the year ended December 31, 2011?
   Acquisition cost of the asset --> $100,000
   Useful life of the asset --> 5 years
   Residual value (or salvage value) at the end of useful life --> $10,000
   Depreciation method --> sum-of-the-years'-digits  method

  Calculation of depreciation expense
   Sum of the years' digits = 1+2+3+4+5 = 15
   Depreciation for 2011 = ($100,000 - $10,000) x 5/15 = $30,000
   Depreciation for 2012 = ($100,000 - $10,000) x 4/15 = $24,000
   Depreciation for 2013 = ($100,000 - $10,000) x 3/15 = $18,000
   Depreciation for 2014 = ($100,000 - $10,000) x 2/15 = $12,000
   Depreciation for 2015 = ($100,000 - $10,000) x 1/15 = $6,000

      Sum of the years' digits for n years
          = 1 + 2 + 3 + ...... + (n-1) + n = (n+1) x (n / 2)

      Sum of the years' digits for 500 years
          = 1 + 2 + 3 + ...... + 499 + 500
          = (500 + 1) x (500 / 2) = (501 x 500) / 2 = 125,250


Depreciation Example 1
 






 
U.S. GAAP Codification
International Financial Reporting Standards (IFRS)
 
Accounting Topics
Inventory Valuation Methods
Depreciation Methods
Revenue Recognition Principle
Accrual Basis vs. Cash Basis Accounting
Basics of Journal Entries
Ratios for Financial Statement Analysis
Overview of Financial Statements

 








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