How to calculate depreciation when there is residual value

Written by d. laverne o'neal
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How to calculate depreciation when there is residual value
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Understanding depreciation is critical to business accounting. Nearly every business requires the acquisition of fixed assets, such as office or manufacturing equipment. Calculating depreciation represents allocation of the cost of an asset during the course of its useful life. Residual value, also known as salvage value, is the value that remains in the asset, once deprecation has begun. Several methods of calculating depreciation exist. Here, we will discuss the straight-line and declining-balance methods.

Skill level:
Moderate

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Instructions

    Straight-Line Method

  1. 1

    Find out what the asset costs. If you were not responsible for the purchase, your accounting or purchasing departments should have the information.

  2. 2

    Find out what the useful life of the asset will be. Your accounting department or operations manager should be able to get you this data.

  3. 3

    Divide the cost of the asset by the useful life figure. The formula for the straight-line depreciation method is cost divided by useful life. Assuming the cost of the asset to be £16,250 and its expected life, five years, the calculation is as follows: ($25,000 / 5 = £3,250. The asset will decline in value by £3,250 each year. After one year, the residual value of the asset will be £16,250 - £3,250 = £13,000. For the second year, the calculation will be £13,000 - £3,250 = £9,750. At the end of five years, the residual value will be zero and the asset will be removed from the books.

    Declining-Balance Method

  1. 1

    Find out the cost of the asset.

  2. 2

    Find out the expected useful life of the asset. Consult your accounting or operations department.

  3. 3

    Figure the rate of decline in value. The formula for the declining-balance method applies a constant factor to the declining asset value. The formula is 100% divided by the expected useful life of the item, then multiplied by 2. If the asset cost £13,000 and the life of the asset is five years, the calculation would be performed as follows: (100%/ 5) X 2 = 40%. By this calculation, the asset's value will drop by 40 per cent every year.

  4. 4

    Apply the rate of decline to the value each year. Example: 40% X £13,000 = £5,200. The salvage value after one year is £13,000 minus £5,200, or £7,800. The second year, the calculation will include that year's residual value, £7,800, minus (40% X £7,800), or £3,120. £7,800 - £3,120 = £4,680. For the third year, you will want to take £4,680 minus (40% X 7,200), which comes to £1,872. £4,680 - £1,872 = £2,808. Continue making the calculation for the useful life of the asset. At the end of the fifth year, the residual value of the asset will be £1,010.

Tips and warnings

  • To learn about other depreciation calculation methods, consult the References below.
  • You must perform depreciation calculations in accordance with current tax law. Be sure you and your accountant are updated relative to changes in the law.

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