Treasury and Fund Management

BY Ma’am Naveeda Shah

Ahtasham Ali 2k18/BBA/17

Depreciation
In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in
a systematic manner until the value of the asset becomes zero or negligible.

An example of fixed assets are buildings, furniture, office equipment, machinery etc.. A land is
the only exception which cannot be depreciated as the value of land appreciates with time.

Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed
asset. This is mandatory under the matching principle as revenues are recorded with their
associated expenses in the accounting period when the asset is in use. This helps in getting a
complete picture of the revenue generation transaction.

An example of Depreciation – If a delivery truck is purchased a company with a cost of Rs.

100,000 and the expected usage of the truck are 5 years, the business might depreciate the
asset under depreciation expense as Rs. 20,000 every year for a period of 5 years.

Main type of depreciation methods are:

1. Straight-line depreciation method
2. Reducing balance depreciation method
3. Sum-of-the-year’s-digits depreciation method
4. Units of production depreciation method

Other types are;

 Sinking Fund Method
 Annuity Method
 Insurance Policy Method
 Discounted Cash Flow Method

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 Treasury and Fund Management
BY Ma’am Naveeda Shah
Ahtasham Ali 2k18/BBA/17

Detailed explain the main depreciation methods

1. Straight-line depreciation method

Straight-line depreciation is a very common, and the simplest, method of
calculating depreciation expense. In straight-line depreciation, the expense
amount is the same every year over the useful life of the asset.
Depreciation Formula for the Straight Line Method:
Depreciation Expense = (Cost – Salvage value) / Useful life

2. Double Declining Balance Depreciation Method

Compared to other depreciation methods, double-declining-balance
depreciation results in a larger amount expensed in the earlier years as
opposed to the later years of an asset’s useful life. The method reflects the
fact that assets are typically more productive in their early years than in
their later years – also, the practical fact that any asset (think of buying a
car) loses more of its value in the first few years of its use. With the double-
declining-balance method, the depreciation factor is 2x that of the straight-
line expense method.
Depreciation formula for the double-declining balance method:
Periodic Depreciation Expense = Beginning book value x Rate of
depreciation

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 Treasury and Fund Management
BY Ma’am Naveeda Shah
Ahtasham Ali 2k18/BBA/17

3. Units of Production Depreciation Method

The units-of-production depreciation method depreciates assets based on
the total number of hours used or the total number of units to be produced
by using the asset, over its useful life.
The formula for the units-of-production method:
Depreciation Expense = (Number of units produced / Life in number of
units) x (Cost – Salvage value)

4. Sum-of-the-Years-Digits Depreciation Method

The sum-of-the-years-digits method is one of the accelerated depreciation
methods. A higher expense is incurred in the early years and a lower
expense in the latter years of the asset’s useful life.
In the sum-of-the-years digits depreciation method, the remaining life of an
asset is divided by the sum of the years and then multiplied by the
depreciating base to determine the depreciation expense.
The depreciation formula for the sum-of-the-years-digits method:
Depreciation Expense = (Remaining life / Sum of the years digits) x (Cost –
Salvage value)

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