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Depreciation Methods 

Accounting for Inventories

Depreciation Example 1 (pdf)

Depreciation Example 1a (pdf)
Depreciation Example 2 (pdf)
Depreciation Example 2a (pdf)
 
GAAP

Accounting Research Bulletin (ARB) No. 43, Chapter 9C, Para 5

     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, 2006, 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 2006,  2007 and 2008 using straight line depreciation method.  

       Depreciation for 2006

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

       Depreciation for 2007

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

       Depreciation for 2008

           = ($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, 2006, 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 2006,  2007 and 2008 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 2006

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

       Depreciation for 2007

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

       Depreciation for 2008

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

   Double Declining Balance Depreciation Method

Book Value Book Value at the year-

Year Depreciation Rate Depreciation Expense
at the beginning end
2006 $140,000 40% $42,000 (*1) $98,000
2007 $98,000 40% $39,200 (*2) $58,800
2008 $58,800 40% $23,520 (*3) $35,280
2009 $35,280 40% $14,112 (*4) $21,168
2010 $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 2010 is $1,168 to keep book value same as salvage value.
           --> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)
           --> If $8,467 is charged to depreciation expense, book value goes below salvage value ($21,168 - $8,467 = $12,701).
[Example, 150% declining balance depreciation] 
       On April 1, 2006, 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 2006,  2007 and 2008 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 2006

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

       Depreciation for 2007

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

       Depreciation for 2008

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

   Double Declining Balance Depreciation Method

Book Value Book Value at the year-

Year Depreciation Rate Depreciation Expense
at the beginning end
2006 $140,000 30% $31,500 (*1) $108,500
 2007 $108,500 30% $32,550 (*2) $75,950
2008 $75.950 30% $22,785 (*3) $53,165
2009 $53,165 30% $15,950 (*4) $37,216
2010 $37,216 30% $11,165 (*5) $26,051
2011 $37,216 30% $11,165 (*5) $26,051

   (*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) $21,168 x 30% x 12/12 = $8,467
           --> Depreciation for 2010 is $1,168 to keep book value same as salvage value.
           --> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)
           --> If $8,467 is charged to depreciation expense, book value goes below salvage value ($21,168 - $8,467 = $12,701).

 
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 of Sum-of-the-years-digits method]

      Company A purchased the following asset on January 1, 2006.  What is the amount of depreciation expense for the year ended
December 31, 2006?
   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 2000 = ($100,000 - $10,000) x 5/15 = $30,000
   Depreciation for 2001 = ($100,000 - $10,000) x 4/15 = $24,000
   Depreciation for 2002 = ($100,000 - $10,000) x 3/15 = $18,000
   Depreciation for 2003 = ($100,000 - $10,000) x 2/15 = $12,000
   Depreciation for 2004 = ($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 (pdf)
   Depreciation Example 1a (pdf)
   Depreciation Example 2 (pdf)
   Depreciation Example 2a (pdf)
 

 
Other Accounting Topics   
 
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  Depreciation Methods
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  Accrual Basis vs. Cash Basis Accounting
  Basics of Journal Entries
  Ratios for Financial Statement Analysis
 
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  Statements of Financial Accounting Standards (SFAS)
 

 
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