What is Depreciation?
-Depreciation is the process of allocation of cost of an asset over its useful life in systematic manner.
What is Useful Life?
-Useful life is the expected service life of an asset.
What is Salvage value?
-Salvage value is the estimated value at the end of the service life of an asset.
How to Calculate Depreciation:
- Normally three methods are used to calculate depreciation of an asset:
A. Straight Line Method:
- Periodic depreciation is the same for each period of an asset over the service life of an asset.
B. Declining Balance Method:
- A constant rate is used on the book value at the beginning of each period of the asset.
C. Units of Activity Method:
- Depreciation is calculated using the units of activity used in that period.
Example: ABC Company purchased a new machine on 01 July 2020 costing BDT 70,000. Its estimated life is 5 years and salvage value at the end of service life is BDT 10,000. The machine is expected to be used for 2,40,000 hours during its estimated life. Calculate depreciation for 2020 and 2021 using (1) Straight line method, (2) Declining balance method and (3) Units of Activity method (assume 40,000 hours used in 2020 and 90,000 hours used in 2021).
Solution:
1. Straight Line Method:
Depreciation (2020) = Total Depreciable Cost/ Total Useful life * Partial period
= (70,000-10,000)/5 * (6/12)
= BDT 6,000.
Depreciation (2021) = Total Depreciable Cost/ Total Useful life
= (70,000-10,000)/5
= BDT 12,000.
2. Declining Balance Method:
Depreciation rate to be used = (100 / Estimated life) * 2
= (100 / 5) * 2
= 40%
Depreciation (2020) = Book value at the beginning of this period * Depreciation rate * Partial period
= 70,000 * 40% * (6/12)
= BDT 14,000.
Depreciation (2021) = Book value at the beginning of this period * Depreciation rate
= (70,000-14,000) * 40%
= BDT 22,400.
3. Units of Activity Method:
Depreciable cost per unit = Total Depreciable Cost/ Total Units of Activity
= (70,000-10,000) / 2,40,000
= BDT 0.25
Depreciation (2020) = Depreciable cost per unit * Units of Activity in 2020
= 0.25 * 40,000
= BDT 10,000.
Depreciation (2021) = Depreciable cost per unit * Units of Activity in 2021
= 0.25 * 90,000
= BDT 22,500.