# Understanding Methods for Calculating Depreciation Expense

Depreciation is the allocation of the cost of a fixed asset over an extended period of time. This conforms to the matching principle of accounting where the periodic adjusting entries to record depreciation expense are made to correspond with the revenues — the use of that asset helped to create during a specific accounting period. Three common methods used in calculating depreciation expense are

• straight-line
• units-of-production
• double-declining balance

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### Calculating Depreciation Expense Using the Straight-Line Method

This tends to be the simplest and therefore the easiest as well as the most used method of calculating depreciation expense.

As an example, assume that a business purchases a fixed asset costing \$50,000 with a residual (salvage) value of \$10,000 and an estimated useful life of 10 years. Three steps are involved in calculating the depreciation expense using the straight-line method:

1. Calculate the depreciable cost of the asset. This is the asset’s cost less its residual value. In the example above, the depreciable cost is \$40,000 (\$50,000 less \$10,000).
2. Calculate the depreciation rate. This is done by dividing the number one by the total number of estimated years of the asset’s useful life. In this case, one divided by ten is 10%.
3. Multiply this rate by the depreciable cost to get the amount of depreciation expense to be taken for each of the ten years. In the above example that would be \$4,000 (\$40,000 x 10%).
4. The adjusting accounting entry would be a debit to the depreciation expense account and a credit to the accumulated depreciation account for \$4,000.

### Calculating Depreciation Expense Using the Units-of-Production Method

This method relies upon unit productivity of the asset expressed in estimated total hours, production quantity, or miles driven of the asset. Assume that in the above example it is determined that the asset in question will produce 40,000 units, and during the current year it has produced 5,000 units. Again there are three steps involved to determine the depreciation expense.

1. Calculate the depreciable cost of the asset. This is the asset’s cost less its residual value. In the example above, the depreciable cost is \$40,000 (\$50,000 less \$10,000).
2. Calculate the depreciation rate. To do this the residual value of \$40,000 must be divided by the total number of units the asset is expected to produce over its useful life. \$40,000 divided by 40,000 units equals \$1.00 per unit as the depreciation rate.
3. Multiply this rate (\$1.00) by the number of units produced for the year (5,000). \$1.00 x 5,000 units equal \$5,000. This is the amount of depreciation expense to be taken for the year.
4. The adjusting accounting entry would be a debit to the depreciation expense account and a credit to the accumulated depreciation account for \$5,000.

### Calculating Depreciation Expense Using the Double-Declining-Balance Method This method assumes that the asset will be most productive in the first few years it is put into service. Therefore, the depreciation expense is highest for the first year of service and gradually declines over the life of the asset. The steps involved to calculate depreciation expense using the double-declining-balance method are:

1. Calculate the straight-line rate for depreciation (one divided by the number of years of useful life). In the initial example above that would be 10% (one divided by 10).
2. Double the rate (10% x 2 or 20%).
3. Apply this rate to the original cost of the asset for the first year ignoring residual cost. In the above example, the depreciation expense to be taken for the first year would be \$10,000 (\$50,000 x 20%).
4. In succeeding years the declining-balance rate is applied to the new book value which is the asset’s cost minus the accumulated depreciation is already taken on the asset. For the second year, the depreciation expense using this method would be \$8,000 (\$50,000 – \$10,000 first year depreciation x 20%). The third year’s depreciation would be \$6,400 (\$50,000 – \$10,000 – \$8,000 or \$32,000 x 20%). Notice that the 20% depreciation rate is applied to the declining book value (cost minus accumulated depreciation) from year to year which explains the gradual decline in depreciation expense each year.

A long-term asset’s cost may be expensed over its years of useful life. The straight-line method for calculating yearly depreciation expense is the easiest to apply and the most widely used. The units-of-production method is very similar to the straight-line method but uses a specific rate per unit produced to calculate depreciation.

The double-declining- balance method doubles the straight-line rate and applies that rate to the declining book value of the asset to calculate yearly depreciation expense. Since it takes larger amounts of depreciation during the first years of an asset’s useful life, it is referred to as an accelerated depreciation method.

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