Depreciation Definition And How to Calculate it

Do you know about depreciation? Depreciation is a term in the accounting world that is important to understand. Most people view depreciation as a form of loss. However, for those who understand it, this procedure is used as a cost allocation tool. Depreciation even has several methods of calculation.

Curious about the ins and outs of depreciation? Check out the full discussion below!

What is Depreciation?

Depreciation is a consequence of the use of fixed assets and these assets usually experience a decline in quality.

According to common definition, depreciation is a reserve intended to buy new assets to replace old assets that are no longer productive. Meanwhile, according to accounting, depreciation is the allocation of funds obtained from fixed assets into the cost of production or operating expenses caused by the use of assets.

Factors Affecting Depreciation

According to experts, there are several factors that must be considered in determining the cost of depreciation for each period, including:

  • The acquisition cost

Cost is the money you spend to acquire an asset and put it to use.

  • Residual value

The residual of an asset is the total that will be received if the asset is sold, exchanged, or other means when the asset can no longer be used. The salvage value also includes the reduction of costs incurred during the period of use.

  • Estimated useful life

The estimated useful life of an asset is influenced by how it is maintained and the policies adopted in reparations. Estimates can be expressed in units of time, units of working hours, or units of production. You should also consider the causes of the functional and physical wear and tear of the asset.

  • Pattern of use

Usage patterns are often perpetuated in calculating the total depreciation expense for the period.

Depreciation Calculation Methods in the World of Accounting

An accountant in a business must apply a systematic and rational method of calculating depreciation. The following are several methods of calculating depreciation that can be used:

  • Straight-Line Method

The straight-line method is most often used to calculate depreciationThe straight-line method assumes depreciation as a function of time, not a function of usage. However, this method is considered unrealistic because the same asset is used every year. The calculation formula is as follows:

  • (Cost – Value residue) ÷ Age Economical = Depreciation
  • Cost ÷ Age Economical = Depreciation
  • Descending expense method ( Decreasing Charge Method )

This second method is an accelerated depreciation method which provides a higher depreciation expense in the initial period and becomes lower in the next period. This method is divided into two, namely according to the number of years and declining balances.

  • Activity Method

The third method considers depreciation as a function of productivity or usage. So, activity method is not based on time side. That way, depreciation does not have a problem because its use tends to be easy to measure. Here is the activity method formula.

Depreciation = [(Cost – Value residue) × Estimated Useful Life] ÷ Productive Age

  • Special Depreciation Method

The special depreciation method aims to determine the depreciation of the benefits of the company’s assets. However, in certain cases, companies cannot use other methods because the assets involved have unique characteristics.

There are two ways that you can apply, namely the group method and the mixed method. The group method is used on homogeneous assets and has almost the same function. Meanwhile, mixed methods are used according to the accountant’s wishes.

  • Double Declining Method

This method does not involve a residual value. The double-declining balance method calculates a straight-line depreciation rate with no residual value, then multiplies by two. The double declining method determines depreciation by the book value of the asset at the beginning of each period. Here is the formula.

(Cost ÷ Age Economical) × 2 = Depreciation

  • Unit of Production Method

This method is based on units of production with units of time (hours) or weight (kg). The formula used is

  • Depreciation = Depreciation per Unit × Usage
  • Depreciation = (Cost – Residual Value) × (Use ÷ Estimated Age)

Have you understood the description that has been conveyed above? Every fixed asset in the company must be depreciated so that its book value can be known. Therefore, depreciation is an important thing to study carefully. Hopefully this information can help you to know more about the world of finance.

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