Definition of Depreciation
Depreciation is an accounting technique for spreading out the expense of a tangible item over its useful life. Depreciation showcases the exact used asset’s value. It enables businesses to compare the cost of assets to the revenue generated from the asset.
An accountant records depreciation for all capitalized assets that have not yet been fully depreciated after an accounting period. The entry in the journal includes a:
The debit for the expense of depreciation is carried over to the income statement credit to the balance sheet's reported accumulated depreciation.
Straight-Line The simplest method for keeping track of depreciation is the straight-line method. Throughout the asset's entire useful life, until the point at which the total investment has been depreciated to its salvage value, it records an equal depreciation expense each year.
Depreciation per annum = (Cost of an Asset - Residual Value)/Useful life of an Asset
Declining Balance An accelerated depreciation approach is the decreasing balance method. This method lets the machine depreciates annually at its straight-line depreciation % times the amount still depreciable. The same percentage results in a more considerable depreciation expenditure in the early years, reducing yearly because an asset's carrying value was higher earlier.
Depreciation per annum = (Net Book Value - Residual Value) * %Depreciation Rate
Double-Declining Balance (DDB) Another technique for calculating depreciation is the double-declining balance (DDB) method. Applying this rate to the depreciable base, which is the asset's book value, over the remainder of the estimated life of the asset after multiplying the asset's useful life by its reciprocal and by two. As a result, it moves along roughly twice as quickly as the declining balance technique.
DDB equals (Net Book Value - Salvage Value) times (2 / Useful Life) times the depreciation rate.
Sum-of-the-Years Digits (SYD) Accelerated depreciation is also possible using the sum-of-the-years' digits (SYD) approach. Start by adding up all the asset's projected lifespan digits.
Units of Production An estimate of the overall units an asset will create over its useful life is needed for this procedure. The depreciation cost is then computed annually based on the units produced. Finally, this approach calculates depreciation costs based on the output generation of the asset.
Which assets are subject to depreciation?
Owned by you
Serve your business or generate income
Have a predetermined functional life
Expect it to endure longer than a year.
Benefits of Charging for Depreciation
- Depreciation is a tax-deductible expense, so you should consider it if you want to reduce your tax liability.
- Depreciation must be calculated in the financial statement as per the Companies Act 2013.
- If it is not considered, expenditure in the best interests of fixed assets is not considered, and the profit may appear to be relatively high, particularly in industries that require a lot of gear and equipment. This could lead to a significant redistribution of profits to shareholders, leaving the business short on cash when it needs to repair an asset.