Depreciation
Depreciation Methods
1. Straight Line / 2. Declining Balance / 3. Sum-of-the-year’s-digits / 4. Unit of Production
It is a process of allocating Costs
Cost to be allocated = Acquisition Cost (Purchase Price) – Salvage Value
Depreciation is a systematic and rational process of distributing the cost of tangible assets over the life of assets
1. Straight Line Depreciation Method
Illustration Question:
On June, 2011, a Company purchased an equipment at a cost of SAR 140,000, having a life span of 5 years. At the end of the 5th year the salvage value will be SAR 20,000. Calculate the depreciation for 2011 & 2012 using
straight line depreciation method.
Depreciation = (Cost – Residual/ Salvage Value)
Useful Life
Depreciate at equal rate throughout the life
Answer
Cost = 140,000
Salvage Value = 20,000
Life = 5
Depreciation = (Cost – Residual/ Salvage Value)
Useful Life
Depreciation for 2011 = (140,000 – 20,000) 6
5 12
120,000 1 = 24,000 = SR 12,000
5 2 2
Depreciation for 2012 = (140,000 – 20,000)
5
= 120,000 = SR 24,000
5
2. Declining Balance Method
Book Value of the Asset depreciate every year
Depreciation Rate = (100)/(Life in Years)
Depreciation = Book Value x Depreciation Rate
Book Value = Cost – Accumulated Depreciation
Double (200%) Declining Balance Method 40%
Triple (300%) Declining Balance Method 60%
150% Declining Balance Method 30%
50% Declining Balance Method 10%
If the Asset Value depreciation is 20% in the Straight Line Method:
Illustration Question:
On January, 2011, a Company purchased an equipment at a cost of SAR 140,000, having a life span of 5 years. The depreciation rate is 20%.
a) Calculate the depreciation from 2011 to 2015 using Declining Balance Depreciation method. Also calculate the salvage value of the equipment at the end of the year 2015.
b) Calculate the depreciation from 2011 to 2015 using Double Declining Balance Depreciation method. Also calculate the salvage value of the equipment at the end of the year 2015.
Answer (a)
Year Book Value (SAR) in the beginning
Depreciation
2011 140,000 (140,000) (20/100) = 28,000
2012 140,000 – 28,000 = 112,000 (112,000) (20/100) = 22,400
2013 112,000 – 22,400 = 89,600 (89,600) (20/100) = 17,920
2014 89,600 – 17,920 = 71,680 (71680) (20/100) = 14,336
2015 71,680 – 14,336 = 57,344 (57,344) (20/100) = 11,469
At the end of the year 2015, the SALVAGE VALUE = 57,344 – 11,469 = SR45,875
Depreciation = Book Value x Depreciation Rate
Book Value = Cost – Accumulated Depreciation
Answer (b) Double Declining (40%)
Year Book Value (SAR) in the beginning
Depreciation
2011 140,000 (140,000) (40/100) = 56,000
2012 140,000 – 56,000 = 84,000 (84,000) (40/100) = 33,600
2013 84,000 – 33,600 = 50,400 (50,400) (40/100) = 20,160
2014 50,400 – 20,160 = 30,240 (30,240) (40/100) = 12,096
2015 30,240 – 12,096 = 18,144 (18,144) (40/100) = 7258
At the end of the year 2015, the SALVAGE VALUE = 18,144 – 7258 = SR10886
Depreciation = Book Value x Depreciation Rate
Book Value = Cost – Accumulated Depreciation
3. Sum-of-the-year’s-digits method
1st Year = n/(1+2+3+ ……. + n)
2nd Year =(n – 1)/(1+2+3+ ……. + n)
3rd Year = (n – 2)/(1+2+3+ ……. + n)
Last Year = 1/(1+2+3+ ……. + n)
Depreciation= (Cost – Salvage Value) (Fraction of the Year)
If ‘n’ is number of years;
Fraction for the years is given by:
This is done to reduce tax payments. Depreciation expense is a non-cash expense so
must be used to reduce tax payments and get higher net cash inflows
Illustration Question
A company purchased an Asset on January, 2011. The Cost of the Asset is SR 100,000 and its life is 5 years. The Salvage Value at the end of useful life will be SR 10,000. Using Sum-of-the-years-digits method calculate the depreciation from 2011 to 2015.
Answer
Sum of the Years = 1+2+3+4+5 =15
Depreciation for 2011 = (100,000 – 10,000) (5/15) = SR 30,000
Depreciation for 2012 = (100,000 – 10,000) (4/15) = SR 24,000
Depreciation for 2013 = (100,000 – 10,000) (3/15) = SR 18,000
Depreciation for 2014 = (100,000 – 10,000) (2/15) = SR 12,000
Depreciation for 2015 = (100,000 – 10,000) (1/15) = SR 6,000
Short-Cut to Measure Sum of the Years
For n’ years:
Sum of the Years = (n+1) (n/2)
ILLUSTRATION:
For 500 Years = (500+1) (500/2)
= (501) (250)
= 125,250
4. Units of Production Method
Illustration Question: A company purchased a car at a Cost of SR 52,000. Its estimated running (Units of Output) for 5 years is 10,000 miles, distributed as follows.
1st Year = 4000; 2nd Year = 2500; 3rd Year = 1500; 4th Year = 1000; 5th Year = 1000
The Residual Value after 5 years is SR 2000. Calculate the Depreciation Expenses and Book Value for each year (for 5 years)
Depreciation = Cost – Residual Value
Estimated Units of Output
AnswerCost of the Asset (vehicle) = SR 52,000Residual Value = SR 2,000Estimated Units of Output (Miles) = 10,000Depreciation Expense = Cost – Residual Value
Estimated Units of Output
= (52,000 – 2,000)/10,000 = SR 5 per mile
Years Depreciation Expense (SR)
Book Value (SR) at the year
end
0 52,000
1 4,000 x 5 = 20,000 52000 – 20000 = 32,000
2 2,500 x 5 = 12,500 32000 – 12500 = 19,500
3 1,500 x 5 = 7,500 19500 – 7500 = 12,000
4 1,000 x 5 = 5,000 12000 – 5000 = 7,000
5 1,000 x 5 = 5,000 7000 – 5000 = 2,000