How to calculate depreciation in accounting

Written by mark kennan
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How to calculate depreciation in accounting
Company vans can be depreciated over time. (van fano Denmark image by david harding from Fotolia.com)

Depreciation refers to the accounting practice of writing off some of the value of assets each year to account for the declining value of the items. Depreciation helps companies more accurately account for expenses as they are incurred rather than when they are paid for. For example, if a company purchases a new drilling machine for £3 million that will last 10 years, without depreciation the company would have a £3 million expense in the first year and no expenses in future years. Two common ways to depreciate in accounting are the straight-line method and the double-declining balance method.

Skill level:
Moderate

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Instructions

    Straight Line Method

  1. 1

    Estimate the salvage value of the item. The salvage value is how much you expect the item to be worth when you are finished using it. If you expect it to have no value, use £0.

  2. 2

    Subtract the salvage value from the original value of the item. For example, if you bought a van for the company that cost £9,750 and you expect it to be worth £3,250 when you are finished with it, you would subtract £3,250 from £9,750 to get £6,500.

  3. 3

    Divide the difference in values from Step 2 by the expected lifespan of the item to determine the depreciation per year. In this example, if you expected the van to last 10 years, you would divide £6,500 by 10 to find the depreciation would be £650 per year.

    Double-Declining Balance Method

  1. 1

    Estimate the salvage value of the item. The salvage value is how much you expect the item to be worth when you are finished using it. If you expect it to have no value, use £0.

  2. 2

    Divide 2 by the number of years you expect the item to last to calculate the percentage of the value that the item will lose each year. For example, if you expect a van to last 10 years, you would divide 2 by 10 to get 20 per cent.

  3. 3

    Multiply the percentage from Step 2 by the value of the item to calculate the depreciation for the first year. In this example, if the van was worth £9,750, you would multiply £9,750 by 0.2 to find depreciation for the first year would be £1,950.

  4. 4

    Subtract the depreciation from the value of the item. In this example, you would subtract £1,950 from £9,750 to find the new value to be £7,800.

  5. 5

    Multiply the new value by the same percentage to calculate depreciation in the second year. In this example, you would multiply £7,800 by 0.2 to find that depreciation would be £1,560.

  6. 6

    Repeat Steps 4 and 5 until you have depreciated the item to its salvage value. In this example, if the salvage value were £3,250, in the sixth year the depreciation would get a value of £3,194.80 for the van. However you cannot depreciate the item past the salvage value so you would depreciate it to £3,250 and stop.

Tips and warnings

  • The double-declining balance method will depreciate your items at a faster rate. This method is more appropriate for items that lose most of their value in the first few years of use.

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