Fixed asset accounting depreciation methods

Depreciation is used to expense a portion of an asset that relates to the revenue generated by that asset. This allows companies to expense portions of an asset over time, generally at a steady rate, so that the cost of the asset is allocated over its useful life. Depreciation represents the amount of an asset’s value that has been used. If depreciation was not used, then organizations would have to expense the entire value of an asset when the purchase occurs. This results in large losses in the month when the asset is purchased and unusually high profits in the subsequent months.

In this post, we will highlight a few popular depreciation methods to help you determine which method would best fit your business needs.

Before selecting a depreciation method, there are several important factors that need to be considered when calculating depreciation.  

• Useful life – Useful life can either be the time period over which you expect an asset to be productive or the number of units of production an asset is expected to generate. Depreciation is recognized over the useful life of an asset. 
• Salvage value – Salvage value is the amount your company may be able to sell their assets for when they eventually dispose of them. Depreciation is calculated on an asset cost minus any estimated salvage value. 
• Depreciation methods – Depreciation can be calculated evenly over the useful life of an asset, or an accelerated method can be used. The most popular ‘steady’ depreciation method is the straight-line method, which records an even amount of depreciation of an asset’s useful life. An accelerated depreciation method includes the double declining balance method. 

Straight-line depreciation is the most commonly used and straightforward method for depreciating an asset. Deprecation is recognized evenly over the useful life of an asset. The main advantage of using a steady depreciation rate is the ease of calculation. Other reasons companies may opt for the straight-line depreciation method is because they have a relatively small amount of fixed assets, are public companies, and are not consistently earning taxable income.  

Steps to calculate the annual depreciation of an asset using the straight-line method: 

1. Subtract the salvage value of the asset from the cost of the asset 
2. Determine the estimated useful life for the asset 
3. Divide the estimated useful life (in years) into 1 to determine depreciation rate 
4. Multiply the depreciation rate by the result from calculation #1 

The double-declining balance method (DDB) is a form of accelerated depreciation. Accelerated depreciation methods are more appropriate than the straight-line method if an asset experiences a very high level of usage during the first few years of its useful life. Organizations also use this method to reduce the reported amount of taxable income over the first few years of an asset’s useful life. Some companies may avoid this method due to additional calculations and record keeping. However, accounting software like Microsoft Dynamics 365 Business Central and NetSuite ERP include fixed asset management modules that can overcome this issue. 

Steps to calculate the depreciation rate using DDB: 

1. Determine the cost of the asset and the salvage value 
2. Determine the estimated useful life for the asset 
3. Deprecation rate = (100%/Years of useful life) x 2 
4. To determine the amount of depreciation each year, multiply the depreciation rate by the book value of the asset at the beginning of the year 

Like the Straight-Line Method, the DDB calculation will proceed until the asset’s salvage value is reached, at which point the depreciation calculation will stop.

Using this method, the amount of depreciation charged will vary and depends on the amount the asset was used. More depreciation would be charged in periods where the asset has high usage, and less depreciation would be charged in periods where the asset had lower usage. This is the most accurate way to charge depreciation since it is linked closely to wear and tear on an asset. However, in order to use the units of production method, organizations must be able to track asset usage and be able to effectively estimate total usage over the life of an asset. Due to these requirements, this method is generally used with organizations that have more expensive assets. 

Steps to calculating the total depreciation expense for the accounting period: 

1. Estimate production of the asset over its useful life (either in hours or number of units produced) 
2. Subtract the estimated salvage value from the cost of the asset to get the net depreciable cost 
3. Divide the total estimated usage from the net depreciable cost to yield the deprecation cost per hour or unit 
4. Multiply the number of hours of usage or units of actual production by the depreciation cost per hour or unit to get the total depreciation expense for the accounting period 

If the estimated number of hours or units of production for the asset changes over time, you can incorporate these changes into the calculation of the depreciation cost per hour or unit of production. This will alter the depreciation expense on a go-forward basis. 

​Rand Group combines the business acumen of CPAs and industry specialists with the technology expertise of software engineers and data scientists to help clients use technology for business success. Rand Group offers the right combination of ingenuity, dedication, and professionalism to help drive real business results. Our team of CPAs, industry specialists, software engineers, and data scientists can help you select the right depreciation method and implement a powerful ERP system that supports fixed asset management.

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