Depreciation Policy
Depreciation is the allocation of the entire cost of depreciable assets to the operating expense for a series of fiscal periods. The most common methods of depreciation include:
1) Straight-line method
Under this method a fixed amount is charged every year for the entire useful life of the asset. The original cost minus the salvage value, if any, is divided by the estimated useful life in years and charged every year.
2) Service-Hours method
This method takes into account the running time of the asset for the purpose of calculating the amount of depreciation.
3) Productive Output method
In this method, an estimate of the units of output the asset will produce during its entire life will be made and accordingly depreciation charged.
4) Diminishing Balance method
This method yields its diminishing annual depreciation charge by applying a constant rate to the written down value of the cost of an asset.
5) Sum of the years digit method
Depreciation rate is expressed in fractions; we have to add the numbers representing the period of life, use the sum thus obtained as a denominator and use as numerator, the same numbers taken in reverse order and finally multiply the net asset value by the fractions thus produced.
6) Double declining balancing method
Under this method, the depreciation is charged on the reducing balance method but the rate of depreciation is determined by multiplying the straight line rate by two. In this case, residual value is ignored.
7) Revaluation Method
Assets like loose tools, livestock, packing materials etc., cannot be depreciated under straight-line method or reducing balance method and hence revaluation method is used. The difference between the opening value and the revalued amount is treated as depreciation. If there is any appreciation resulting, it would be treated as capital reserve.
8) Replacement method
This method does not record depreciation until a unit is replaced. When unit is replaced at a time, the amount equal to the cost of the new asset less the salvage value is charged to depreciation.
9) Other methods of depreciation
The other methods of depreciation include Annuity method, Depreciation Fund method, Insurance Policy method, Depletion method etc.
Example: Straight-line method: Asset value: $10,000, Salvage value: $1,000, Useful life = 3 years.
Solution: Depreciation per year -> ($10,000-$1,000)/3 years -> $3,000 per year for 3 years period.
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