How to Calculate Depreciation
All businesses and organisations need to account for the consumption, or depreciation, of their assets over time in a way which accounts for the assets’ declining value. Depreciation is defined as the value of an asset over its useful life, and there are several methods used when calculating depreciation on assets. It is important to understand these methods, as they allow an organisation to spread the cost of a fixed asset over the expected useful life of that asset.
The simplest method of calculating depreciation on assets is the straight line method. The straight line method divides the depreciable value of the asset by the asset’s life, or number of years the asset will be kept and used. If the asset has a salvage value, or a residual value after it has finished being used, this is deducted from the overall value of the asset. For example, if you were calculating depreciation on an asset with a useful life of 5 years, which originally cost $10,000 and which had a salvage value of $1,000, you would use the following sum: ($10,000-$1,000)/5 = $1,800.
You can also calculate depreciation on assets using an accelerated depreciation method, such as declining balance or sum of years’ digits.
The declining balance method includes an “accelerator,” so the asset depreciates more in the beginning of its useful life. This method is used for assets like cars, which are known to depreciate more when they’re new.
The sum of years’ digits adds together the number of years in the asset’s useful lifespan, starting from new and going back to one. For example, an asset with a life of 5 years would have this sum of digits: 5+ 4+ 3 +2 + 1 = 15. Then in the first year divide the sum by the largest number (5 / 15); in the second year the sum is divided by the second largest number (4 / 15) and so on, down to one, to find the percentage of depreciation rate for each year.