The calculation of asset depreciation is essential for any business as this can help them figure out how much value their assets can lose during the year. Since assets are an expense, you need to do your asset depreciation to know if your business is gaining profit. You also need to include this in your accounting books so you can reduce your tax bill and measure the value of your business.
Calculation of asset depreciation can be challenging; that’s why we are here to help you with the process. Before learning about the methods you can use, you need to have the cost of an asset, its residual value, and its useful life. After knowing these things, you can apply the methods below to calculate asset depreciation for your business:
1. Use the Straight-Line Method
One of the simplest ways to calculate your asset depreciation is by using the straight-line method. The straight-line method’s primary basis is the useful life of the assets, and the assets depreciate the same amount every year. In this method, you only have to subtract the book value of your asset from its scrap value. Then, you need to divide the difference by your asset’s useful life.
For example, a company buys a steel mould for two million dollars and uses it to manufacture plastic chairs for 10 years. Then, they predicted that it would have a scrap value of 400 thousand dollars. In this case, you can compute the total depreciation by subtracting the scrap value of 400 thousand dollars from the cost of the steel mould of two million dollars. To help you understand more, here’s the formula:
$2m – $0.4m = $1.6m
If you spread this evenly over 10 years, then you can expect to charge depreciation at 10% of $1.6m each year. If you take a look at its formula, here’s how it will look like:
Depreciation per year = 10% x $1.6m = $160k
The steel mould’s carrying value at the end of the first year is $2m – $160k = $1.84m
This carrying value is the asset’s worth after factoring in its depreciation value.
2. Use the Reducing Balance Method
The reducing balance method is where the assets depreciate more in their earlier years compared to later years because they are more useful and productive.
In this method, you need to apply a depreciation factor to the asset’s carrying value to calculate the depreciation charge. Using the same example above, let’s take a look at how this method works:
The depreciation factor is 200% ÷ 10 years (the asset’s useful life), or 20% each year.
So the depreciation of the steel mould after the first year of use is:
($2m – $0.4m) × 20% = $320k
At the end of the first year, the asset’s carrying value is $2m – $320k = $1.68m.
At the end of the second year, the depreciation of the steel mould will be lower:
($1.68m – $0.4m) x 20% = $256k
And the asset’s carrying value at the end of the second year of use is $1.68m – $256k = $1.424m.
There are more available methods you can use that are not mentioned here. However, if you find these methods complicated enough, perhaps you should seek help from a professional accountant to calculate your asset depreciation. This way, you can focus on the main core of your business, and you can get a more accurate picture.
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