How to Calculate Depreciation

Every year, when the accounts of any company are closed and tallied, the most important deductions that are made in the books of accounts, balance sheet and final accounts, are that of depreciation. The value of depreciation is deducted from the current monetary value of certain fixed assets, irrespective of their cost price, face value and current market value. Depreciation is deducted from the value of the assets, due to the fact that everyday use of certain fixed assets result into wear and tear, thereby reducing the monetary value of the asset. There has been much debate regarding depreciation and its importance. Most of the experts in finance, bookkeeping and accountancy, regard depreciation as complex and insignificant. On the other hand, some experts regard depreciation as a very effective technique when it comes to assets such as machinery or loose tools, as the value of such assets indeed decrease with use and time. But in cases of fixed assets such as real estate, it is exactly the opposite, as inflationary cycles of the economy push up the value of such assets. Thus, the usefulness of the phenomenon of depreciation still remains a debate.

Legal systems and government agencies monitoring the finance management and accounting have made the calculation of depreciation a statutory compliance. Depreciation can be calculated with the help of many different methods. The prominent ones have been elaborated below.

How to Calculate Depreciation Expense

Depreciation expense is calculated on the basis of different methodologies. The basic principle of deduction of fixed sum, is the same. Many organizations calculate depreciation on the basis of straight line depreciation method. The staring line depreciation is the simplest of all. The formula of this method goes as follows:

Straight Line Depreciation = Total Cost of Asset (/) Estimated Life of the Asset

By using this formula, you will receive a particular figure that has to be deducted from the book value of the asset every year. The cost of depreciation is considered to be a legitimate expenditure, and is thus not taxed. There are several advantages of using the straight line depreciation, some of them can be elaborated as follows.

• This kind of depreciation facilities excellent financial planning and inventory management.
• The anticipated depreciation, predicted longevity, of the asset often leads to a very good balance sheet analysis, reduces tax liability, and helps in fixed and recurring expenditure planning.
• The expected depreciation and enhanced finance management facilitates the planning of the inventory. A planned inventory means that the purchase department, finance department and production department have a very quick purchase procedure.

The depreciation in such cases is calculated by deduction of a particular percentage from the value of the asset. The percentage that is deducted can be planned by the management of the company, by taking in consideration many factors such as tax liability, loan that has been taken for purchase of asset, inventory planning, current/recurring expenditures of the assets, etc. Accounting standards that are set by the legal system, put a limit on the percentage that can be deducted from the value of the asset. The following are some of the advantages of declining balance depreciation method.

• This kind of deprecation method is not exactly time bound, and the management is free to decide the percentage of depreciation on the basis of their forecasting.
• The total value of accumulated depreciation is seen in the financial statements that are derived on the basis of inventories.
• As the percentage based deductions are brief representations, it proves easy to the management and decision makers to take decisions.

Though the phenomenon of deprecation sounds irrelevant and unnecessary in some cases, it is a statutory requirement, and hence, has to be complied with. It is also advisable to analyze the asset on the basis on its productivity, need and cost. One must also consider estimating recurring expenditures such as servicing, repairs and energy consumption.