Commerce graduates are quite familiar with the depreciation term. While generating a balance sheet, the depreciation value of an asset is deducted from the fixed asset to get the final book value of an asset. 

Determining an asset’s book value is crucial while maintaining the books of accounts. Every year when your business has to prepare a balance sheet, it is essential to apply the depreciation to the fixed assets for getting its accurate book value for the said year. In short, depreciation stands crucial in the books of accounting. 

In short, with the help of depreciation, businesses can get the exact book value of their fixed assets, which is important to acknowledge. Also, the depreciation is deducted differently for different types of fixed assets. Hence, we are here with an accounting blog post to acknowledge depreciation and the different types of depreciation methods. 

Let’s begin!

Accounting definition: depreciation

In accounting terms, depreciation is an important calculation that helps deduct the original value of fixed assets with the passage of time and usage. The fixed assets, i.e., plant and machinery, are liable to have a depreciation value right after purchase. 

Precisely, depreciation is counted as a non-cash expense. The depreciation value is not visible, but it is applied every year to determine the present book value of the assets. Companies consider distinct factors while evaluating depreciation, and one of such factors is the depreciation method. 

In the blog further, we will discuss the different types of depreciation methods with examples and formulas. In addition, online accounting software calculates depreciation to the fixed assets as per the type of method added to the system. 

Why is depreciation important?

Many online billing software has an inbuilt depreciation calculator to help businesses get the correct depreciation amount for determining the accurate book value of an asset. Depreciation is higher in the earlier years of an asset, which declines in the later years. Every asset or machinery that the company purchases is set to have a depreciation value. On the other hand, it is important to generate an expense of an asset that is possible by applying any depreciation methods. 

Best accounting software for small businesses generally helps with a depreciation calculator to find the depreciation value instantly. 

3 Types of depreciation methods

There are various types of depreciation methods that companies use for calculating depreciation. We have mentioned below the different depreciation methods and a few examples. 

1. Straight-line depreciation

Straight-Line Depreciation

The straight-line depreciation method is calculated at the end of every year. It is determined by estimating the asset’s useful life and scrap or residual value at the end of the year. It is one of the most simple and popular depreciation methods. 

If you are using online accounting software, it also helps calculate the straight-line depreciation with the following formula. 

Formula

Annual Depreciation Value = Asset Value- Scrap Value/Useful life of the asset.

Example

Let’s assume a company has purchased machinery for 3,00,000, assuming the useful life of the machinery as 20 years. The residual value of the machinery is stated as 20,000. 

Calculating the machine depreciation value with the straight-line method

Depreciation = (3,00,000 – 20,000)/20 

Depreciation Value = 14,000 

So, for the next 20 years, the company will deduct 14,000 from the asset’s original value as depreciation. 

Get Known to Most Common Accounting Terms

2. Double declining balance depreciation

Double Declining Balance Depreciation

Declining balance or double-declining depreciation is one of the most popular depreciation methods for showing more expenses on the asset’s depreciation than the actual value to save tax. Therefore, it is known as the accelerated depreciation method in the books of accounts. 

Declining balance depreciation is best used for maintaining and creating an easy expense management sheet. It is a quicker and more aggressive pattern of calculating depreciation to create a large realized gain while selling the assets.

Formula

Depreciation Value = 2*Straight Line Depreciation Percent * Asset’s Book Value at the Beginning of the Accounting Period.

How do you calculate the Asset’s Book Value at the Beginning of the Accounting Period?

BV = Original cost of the asset – accumulated depreciation 

Example

Support the company purchased machinery for 3,00,000 in 2020 with 5 years of useful life period and scrap value of 20,000. The calculation is as follows to calculate the aggressive depreciation for the machinery using the double-declining depreciation method. 

Straight Line Depreciation % = 1/5 = 20%

So, we can calculate the depreciation rate as 2*20% = 40% per year

The year 2012

Depreciation Value = 2*Straight Line Depreciation Percent * Asset’s Book Value at the Beginning of the Accounting Period.

Depreciation of the machinery = 40% * 3,00,000 = 1,20,000

Year 2013

Depreciation Value = 2*Straight Line Depreciation Percent * Asset’s Book Value at the Beginning of the Accounting Period.

BV = 1,80,000

Depreciation of the machinery = 40% * 1,80,000 = 72,000

Year 2014

Depreciation Value = 2*Straight Line Depreciation Percent * Asset’s Book Value at the Beginning of the Accounting Period

BV = 1,08,000

Depreciation of the machinery = 40% * 1,08,000 = 43,200

3. Units of production

Units of Production

When equal expense rates are assigned to each unit produced by the asset, the units of production depreciation method is applied. Here the depreciation calculation is purely based on the output generated by the asset for the fixed period of the year. 

Formula

Depreciation value = Asset value – scrap value / estimated units over asset’s lifetime * actual units produced 

Example

Suppose printing machinery worth 1,00,00 is purchased by the company with useful life units of 3,00,000 and a residual value of 10,000. It prints 10,000 pamphlets. 

To calculate depreciation with the units of production method, let’s try the formula. 

Calculate per unit depreciation= 1,00,000 – 10,000 / 3,00,000 = 0.3

Total depreciation expense = 0.3 * 10,000 pamphlets = 3000

Also Read: Here Is How Online Accounting Software Can Help Small Businesses

Closing lines

Depending on the need and type of the company, the different types of depreciation methods are applied. By the GAAP, the startups or businesses choose the appropriate depreciation formula and method for calculating accurate depreciation on the assets. 

Our online billing software helps generate quick expense sheets and profit and loss statements, saving the accountants’ time and effort. Connect with Moon Invoice for more information on accounting terms and calculations. Our accounting experts will be happy to help you.

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