TYPES OF DEPRECIATION METHODS :

What is Depreciation?

Depreciation is the reduction in the book value of an asset due to usage over a period of time. In other words, it is the reduction in the economic usefulness of the asset, or the calculation of wear and tear, that may have occurred to the asset. This is also done to report the actual value to tax authorities.
The present value of the asset, i.e., after deducting the depreciation amount, is recorded in the books. To calculate, one needs to take into account the economic life and the expected value or scrap value of the asset after its use in the business is over.
The calculation is non-cash expense that is estimated or forecasted. This process occurs at the end of the financial year and the amount is shown in both the balance sheet and the income statement. This article discusses some of the most common methods of calculating depreciation.

Straight Line Method of Depreciation

This is the simplest, and most commonly used, form of depreciation calculation and refers to reduction of the value as per a constant rate. The graph formed by assets that are depreciated by the straight-line depreciation method is a straight downward-slanting line. The depreciation value is calculated by taking the original, purchase, or historical price, less the scrap value, and dividing it by the useful years or the number of years that the asset would be in use in the business. The rate of depreciation remains constant as a fixed expense throughout the years. This type of depreciation method is useful for those assets in which the usage remains uniform or consistent. Unfortunately, it dos not take into account the fact that all assets do not deteriorate equally.

Reducing Balance Method of Depreciation

This method is commonly known as the written down value method or the sum of the year’s method. In this method, the asset is depreciated at a consistent rate annually. This depreciation method takes into consideration an accelerated rate of depreciation. This is useful for those assets in which a higher value is lost during the beginning years of usage. By following this method, the cost of the asset is spread over the most productive years of its life. To calculate, one needs to add up the sum of all year’s digits and divide it by the length of the useful life. This number is the rate at which the asset must be depreciated until the end of the asset life. The only flaw of this method is that it does not take into account the scrap or residual value of the asset.

Declining Balance Method of Depreciation

This depreciation method is also known as accelerated depreciation method and is similar to the reducing balance method. In this method too, the asset loses most of its value in the beginning of its life. The rate of depreciation is calculated by taking into consideration the number of years it would serve the business. The number 100 would be divided by the number of years. This rate of depreciation would be the rate at which the asset would depreciate during its life.

Double Declining Balance Method of Depreciation

The declining balance method can be slightly twisted into the double declining balance method of depreciation. To calculate the depreciation amount using this method, the accountant would have to calculate the amount using the straight-line method. Once they calculate the total percentage of the asset that needs to be depreciated in the first year, the percentage would have to be multiplied by the remaining balance each year. After some time, the value would be lower than the straight-line rate. This is the point when the double declining method would have to be discontinued and the straight-line would be used until the asset is used.

Unit of Production Method of Depreciation

This depreciation calculation method refers to an association between the asset's ability to do work during its useful life and the decline in the worth of the asset. Unfortunately, this depreciation method does not take into account the expected years of the asset but takes into account the measurable units of use. The units could be anything, including number of items produced or hours used for machinery, number of kms travelled by vehicles, etc. Thus, the depreciation is calculated by the actual usage of the asset.