Depreciation

Depreciation Methods

1. Straight Line / 2. Declining Balance / 3. Sum-of-the-year’s-digits / 4. Unit of Production

It is a process of allocating Costs

Cost to be allocated = Acquisition Cost (Purchase Price) – Salvage Value

Depreciation is a systematic and rational process of distributing the cost of tangible assets over the life of assets

1. Straight Line Depreciation Method

Illustration Question:

On June, 2011, a Company purchased an equipment at a cost of SAR 140,000, having a life span of 5 years. At the end of the 5th year the salvage value will be SAR 20,000. Calculate the depreciation for 2011 & 2012 using

straight line depreciation method.

Depreciation = (Cost – Residual/ Salvage Value)

Useful Life

Depreciate at equal rate throughout the life

Answer

Cost = 140,000

Salvage Value = 20,000

Life = 5

Depreciation = (Cost – Residual/ Salvage Value)

Useful Life

Depreciation for 2011 = (140,000 – 20,000) 6

5 12

120,000 1 = 24,000 = SR 12,000

5 2 2

Depreciation for 2012 = (140,000 – 20,000)

5

= 120,000 = SR 24,000

5

2. Declining Balance Method

Book Value of the Asset depreciate every year

Depreciation Rate = (100)/(Life in Years)

Depreciation = Book Value x Depreciation Rate

Book Value = Cost – Accumulated Depreciation

Double (200%) Declining Balance Method 40%

Triple (300%) Declining Balance Method 60%

150% Declining Balance Method 30%

50% Declining Balance Method 10%

If the Asset Value depreciation is 20% in the Straight Line Method:

Illustration Question:

On January, 2011, a Company purchased an equipment at a cost of SAR 140,000, having a life span of 5 years. The depreciation rate is 20%.

a) Calculate the depreciation from 2011 to 2015 using Declining Balance Depreciation method. Also calculate the salvage value of the equipment at the end of the year 2015.

b) Calculate the depreciation from 2011 to 2015 using Double Declining Balance Depreciation method. Also calculate the salvage value of the equipment at the end of the year 2015.

Answer (a)

Year Book Value (SAR) in the beginning

Depreciation

2011 140,000 (140,000) (20/100) = 28,000

2012 140,000 – 28,000 = 112,000 (112,000) (20/100) = 22,400

2013 112,000 – 22,400 = 89,600 (89,600) (20/100) = 17,920

2014 89,600 – 17,920 = 71,680 (71680) (20/100) = 14,336

2015 71,680 – 14,336 = 57,344 (57,344) (20/100) = 11,469

At the end of the year 2015, the SALVAGE VALUE = 57,344 – 11,469 = SR45,875

Depreciation = Book Value x Depreciation Rate

Book Value = Cost – Accumulated Depreciation

Answer (b) Double Declining (40%)

Year Book Value (SAR) in the beginning

Depreciation

2011 140,000 (140,000) (40/100) = 56,000

2012 140,000 – 56,000 = 84,000 (84,000) (40/100) = 33,600

2013 84,000 – 33,600 = 50,400 (50,400) (40/100) = 20,160

2014 50,400 – 20,160 = 30,240 (30,240) (40/100) = 12,096

2015 30,240 – 12,096 = 18,144 (18,144) (40/100) = 7258

At the end of the year 2015, the SALVAGE VALUE = 18,144 – 7258 = SR10886

Depreciation = Book Value x Depreciation Rate

Book Value = Cost – Accumulated Depreciation

3. Sum-of-the-year’s-digits method

1st Year = n/(1+2+3+ ……. + n)

2nd Year =(n – 1)/(1+2+3+ ……. + n)

3rd Year = (n – 2)/(1+2+3+ ……. + n)

Last Year = 1/(1+2+3+ ……. + n)

Depreciation= (Cost – Salvage Value) (Fraction of the Year)

If ‘n’ is number of years;

Fraction for the years is given by:

This is done to reduce tax payments. Depreciation expense is a non-cash expense so

must be used to reduce tax payments and get higher net cash inflows

Illustration Question

A company purchased an Asset on January, 2011. The Cost of the Asset is SR 100,000 and its life is 5 years. The Salvage Value at the end of useful life will be SR 10,000. Using Sum-of-the-years-digits method calculate the depreciation from 2011 to 2015.

Answer

Sum of the Years = 1+2+3+4+5 =15

Depreciation for 2011 = (100,000 – 10,000) (5/15) = SR 30,000

Depreciation for 2012 = (100,000 – 10,000) (4/15) = SR 24,000

Depreciation for 2013 = (100,000 – 10,000) (3/15) = SR 18,000

Depreciation for 2014 = (100,000 – 10,000) (2/15) = SR 12,000

Depreciation for 2015 = (100,000 – 10,000) (1/15) = SR 6,000

Short-Cut to Measure Sum of the Years

For n’ years:

Sum of the Years = (n+1) (n/2)

ILLUSTRATION:

For 500 Years = (500+1) (500/2)

= (501) (250)

= 125,250

4. Units of Production Method

Illustration Question: A company purchased a car at a Cost of SR 52,000. Its estimated running (Units of Output) for 5 years is 10,000 miles, distributed as follows.

1st Year = 4000; 2nd Year = 2500; 3rd Year = 1500; 4th Year = 1000; 5th Year = 1000

The Residual Value after 5 years is SR 2000. Calculate the Depreciation Expenses and Book Value for each year (for 5 years)

Depreciation = Cost – Residual Value

Estimated Units of Output

AnswerCost of the Asset (vehicle) = SR 52,000Residual Value = SR 2,000Estimated Units of Output (Miles) = 10,000Depreciation Expense = Cost – Residual Value

Estimated Units of Output

= (52,000 – 2,000)/10,000 = SR 5 per mile

Years Depreciation Expense (SR)

Book Value (SR) at the year

end

0 52,000

1 4,000 x 5 = 20,000 52000 – 20000 = 32,000

2 2,500 x 5 = 12,500 32000 – 12500 = 19,500

3 1,500 x 5 = 7,500 19500 – 7500 = 12,000

4 1,000 x 5 = 5,000 12000 – 5000 = 7,000

5 1,000 x 5 = 5,000 7000 – 5000 = 2,000