Depreciation Methods Complete Guide
Master all depreciation methods including straight-line, declining balance, units of production, and sum-of-years-digits. Learn when to use each method and how to handle partial years, revisions, and disposals.
Learning Objectives
- ✓Calculate depreciation under all major methods
- ✓Determine which method is appropriate for different assets
- ✓Handle partial-year depreciation
- ✓Account for asset disposals and impairments
1. Depreciation Fundamentals
Depreciation allocates the cost of a long-term asset over its useful life. It is NOT a measure of value decline, but a cost allocation process. Key terms: Cost (purchase price plus costs to prepare for use), Salvage Value (estimated value at end of useful life), Depreciable Base (cost minus salvage value), Useful Life (expected service period).
Key Points
- •Cost allocation, not value measurement
- •Depreciable Base = Cost - Salvage Value
- •Accumulated Depreciation is a contra-asset
- •Book Value = Cost - Accumulated Depreciation
2. Straight-Line Method
The most common method. Depreciation Expense = (Cost - Salvage Value) / Useful Life. Results in equal expense each period. Simple to calculate and appropriate when the asset provides equal benefit each period.
Key Points
- •Equal expense each period
- •Most commonly used method
- •Best when benefit is even over time
- •Formula: (Cost - Salvage) / Life
3. Double-Declining Balance (DDB)
An accelerated method that applies a constant rate to the declining book value. Rate = 2 / Useful Life. First year: Cost × Rate. Subsequent years: Book Value × Rate. Important: Do NOT subtract salvage value initially, but never depreciate below salvage value.
Key Points
- •Accelerated method - more expense early
- •Rate = 2 / Useful Life (ignore salvage initially)
- •Apply rate to book value, not cost
- •Stop when book value reaches salvage value
4. Units of Production
Depreciation is based on actual usage rather than time. Depreciation Rate = (Cost - Salvage) / Total Estimated Units. Annual Expense = Rate × Units Produced. Best for assets where wear is tied to usage, like vehicles or manufacturing equipment.
Key Points
- •Based on actual usage, not time
- •Calculate rate per unit of output
- •Good for matching expense to revenue
- •Requires estimating total lifetime units
5. Asset Disposals
When an asset is sold or discarded, remove both the asset cost and accumulated depreciation. The difference between book value and sale proceeds is a gain or loss. Journal entry: Debit Cash (proceeds), Debit Accumulated Depreciation (full amount), Credit Asset (cost), and record Gain or Loss for the difference.
Key Points
- •Remove cost and accumulated depreciation
- •Recognize gain/loss on disposal
- •Update depreciation to disposal date first
- •Gain/loss = Proceeds - Book Value
High-Yield Facts
- ★MACRS is the tax depreciation system in the US - different from book depreciation
- ★Land is NEVER depreciated - it has unlimited useful life
- ★Revisions to estimates are handled prospectively, not retroactively
- ★Impairment occurs when carrying value exceeds recoverable amount (different from depreciation)
- ★Component depreciation: IFRS often requires depreciating significant parts separately
Practice Questions
1. Equipment costs $50,000, has $5,000 salvage value, and 5-year life. Calculate Year 1 straight-line depreciation.
2. Same equipment using DDB: Calculate Year 1 and Year 2 depreciation.
3. Equipment with $24,000 book value is sold for $28,000. What is recorded?
FAQs
Common questions about this topic
Yes, but it's treated as a change in accounting estimate. Apply the new method prospectively from the change date using the current book value.
Revise the estimate prospectively. Spread the remaining book value (above salvage) over the new remaining useful life.