Methods of calculating depreciation

1. (c) 2001 Contemporary Engineering Economics 1

2. PRESENTED BY:
Javeria
11-arid-3303
MIT-3
University Institute of Information Technology,
Rawalpindi(UIIT,UAAR)
Pakistan

3. Depreciation is the reduction in value of an
asset over time due to:
 wear and tear
 effluxion of time
 obsolescence

4. What Can Be Depreciated?
A qualifying asset for depreciation must satisfy all these
conditions:
 should be used in business
 should have a definite useful life and a life longer than 1 year
 must wear out, become obsolete or lose value

5. Types of Depreciation
Book Depreciation
Tax Depreciation

6. Methods to Calculate Depreciation
 Straight-Line Method
 Declining Balance Method
 MACRS Method

7. Required Factors in Calculating Asset
Depreciation
 Useful life of asset
 Residual value
 Cost basis
 Method of depreciation

8. 1. Straight-Line (SL) Method
Principle
A fixed asset provides its service in a uniform
fashion over its life
Formula
Annual Depreciation = cost – residual value
useful life

9. EXAMPLE
(Straight-Line Method)
Cost of machinery = $45,000
Residual value = $5,000
Useful life = 5 years.
Calculate annual cost of depreciation?
Year Computation Depreciation Accumulated Book Value
Expense Depreciation
$45,000
First (45,000-5,000)/5 $8,000 $8,000 37,000
Second (45,000-5,000)/5 8,000 16,000 29,000
Third (45,000-5,000)/5 8,000 24,000 21,000
Fourth (45,000-5,000)/5 8,000 32,000 13,000
Fifth (45,000-5,000)/5 8,000 40,000 5,000
Total 40,000

10. Example - (Straight-Line Method)
Annual
Depreciation
expense
1 2 3 4 5
Years

11. 2. Declining Balance Method
Principle
A fixed asset provides its service in a decreasing fashion. The book
value is reduced by a fixed percentage each year.
Formula
Annual Depreciation = Depreciation rate * Book value at start of year
Depreciation rate
200% Declining Method: Depreciation rate = 2/useful life
150% Declining Method : Depreciation rate = 1.5/useful life
130% Declining Method: Depreciation rate = 1.3/useful life

12. EXAMPLE
(200% Declining Balance Method)
Cost of machinery = $70,000
Residual value = $5000
Useful life = 5 years
Cost of annual Depreciation?
Year Computation Depreciation Accumulated Book Value
Expense Depreciation
$70,000
First $70,000 x 40% $28,000 $28,000 42,000
Second 42,000 x 40% 16,800 44,800 25,200
Third 25,200 x 40% 10,080 54,880 15,120
Fourth 15,120 x 40% 6,048 60,928 9,072
Fifth 9,072-$5,000 4,072 65,000 5,000
Total 65,000

13. Example – 200% Declining Balance Method
Annual
Depreciation
expense
1 2 3 4 5
Years

14. 3. MACRS Method
Principle
An asset has a fixed life according to the category in
which it falls.
The residual value is always zero.
Formula
Annual Depreciation = cost x appropriate MACRS % rate

15. TABLE OF PROPERTY CLASS AND NUMBER OF YEARS
Years
(c) 2001 Contemporary Engineering Economics 15

16. (c) 2001 Contemporary Engineering Economics 16

17. EXAMPLE
(MACRS Method)
Cost of tractor = Rs. 30,000
Cost of annual Depreciation?
Year Computation Depreciation Accumulated Book Value
Expense Depreciation
$30,000
First 33.33% x 30,000 9,999 9,999 20,001
Second 44.45% x 30,000 13,335 23,334 6,666
Third 14.81% x 30,000 4,443 27,777 2,223
Fourth 7.41% x 30,000 2,223 30,000 0