Ch.

8: Capital Assets
8.3 Depreciation (Pt. II):
Methods of Computing Depreciation
BAT 4MI
Note 4-2
Methods of Depreciation
In this course we are going to focus our discussion around 3 main methods of
depreciation
Straight-Line Depreciation
Declining-Balance Depreciation
Units-of-Production (Output) Depreciation
Straight Line Method
This is the method which we both learned earlier in the course and in Gr. 11
Accounting
The straight-line method simply spreads out the cost of the asset equally
over the life of the asset
The formula for straight-line is as follows:
Straight Line Method: An Example
For example... imagine we have a truck which cost us $6,500 whos useful
life is decided to be 10 years at the point its salvage value will be $500.
Using the formula:
Dep/Yr = (6,500 - 500)/10
= $600
Therefore our truck would depreciate at a
rate of $600 per year.
Depreciation for Fractional Periods
As you might say, we might get an asset during the middle of an accounting
period. How would we account for the depreciation then?
Well instead of trying to calculate depreciation to the day, usually accountants
round depreciation up to the next whole month
This keeps them from having messy calculations to do and is still
conservative
An even more widely used approach, called the half-year convention, is to
record six months depreciation on all assets acquired during the year.
This approach assumes that all the assets depreciation amounts will
average out over the course of the year.
The Declining-Balance Method
The xed-percentage-of-declining balance (diminishing balance) is the
most widely used method of depreciation
This method takes a predetermined percentage rate and uses that to
determine the depreciation on an asset for the year
The formula for the declining-balance method is:
Declining-Balance: An Example
For example... go back to our truck for a second. Imagine now that the truck
we bought for $6,500 is now going to depreciate at a declining-balance rate
of 30%
Using the formula:
Dep Ex. (Yr. 1) = 6,500 x 30% = 1,950
Book Value (Yr. 1) = 6,500 - 1,950 = 4,550
Dep. Ex. (Yr. 2) = 4,550 x 30% = 1,365
Book Value (Yr. 2) = 4,550 - 1,365 = 3,185
Declining Balance vs. Straight-Line
Cost: $6,500.00
Straight Line: Declining Balance:
Yrs of Life 10 Rate 30%
Salvage Value $500.00
Year Depreciation Book Value Year Depreciation Book Value
1 600 $5,900.00 1 $1,950.00 $4,550.00
2 600 $5,300.00 2 $1,365.00 $3,185.00
3 600 $4,700.00 3 $955.50 $2,229.50
4 600 $4,100.00 4 $668.85 $1,560.65
5 600 $3,500.00 5 $468.20 $1,092.46
6 600 $2,900.00 6 $327.74 $764.72
7 600 $2,300.00 7 $229.42 $535.30
8 600 $1,700.00 8 $160.59 $374.71
9 600 $1,100.00 9 $112.41 $262.30
10 600 $500.00 10 $78.69 $183.61
Depreciation Expense Per Year
0
500
1000
1500
2000
2500
3000
1 2 3 4 5 6 7 8 9 10
Year
D
e
p
r
e
c
i
a
t
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Straight-Line Declining Balance
Book Value Per Year
$0.00
$2,000.00
$4,000.00
$6,000.00
$8,000.00
$10,000.00
$12,000.00
1 2 3 4 5 6 7 8 9 10
Year
B
o
o
k

V
a
l
u
e
Straight-Line Declining-Balance
Double-Declining Method
The double-declining method of depreciation is simply a way to generate a
depreciation rate for the declining method.
All we simply do is take the straight-line depreciation, turn it into a percentage
rate, and double it.
It would look as follows:
This would then become our rate in the Declining-Balance Method rate
Double-Declining Method: An Example
For Example... If we had our truck from yesterday...
The truck cost us $6,500, it was going to last 10 years, and it had a salvage
value of $500.
Rate = (1/10) x 2 = 20%
We would then use this rate as our declining-balance rate:
Depreciation (Yr. 1) = 6,500 x 20%
= 1,300
Units of Output Method
For some assets, we might be able to assess its useful life based on how
much of something it will produce, or by some other measure than time
In these cases we would use the following formula, which is very similar to
the straight line formula:
We can use any unit we wish for the unit in this formula just as long as it is
somewhat measurable
Units of Output: An Example
For example... going back to our truck. Imagine now if it could be estimated
that the truck we purchase will be good for 600,000 kilometres, still costing us
6,500 with a salvage value of $500
Using the formula:
Dep/Unit = (6,500 - 500) / 600,000
= $0.01/km
Dep Exp. = 83,400 x 0.01
= $834
Now imagine... that in our rst year we nd that we have driving the truck
83,400 kilometres.
Which Depreciation Methods Do Most Businesses
Use?
For nancial statements
Most businesses would choose straight-line as this would show us as
having a higher net income earlier on.
For Income Tax Purposes
If we are concerned about how much income tax we are paying. The
declining-balance method will make our net income lower earlier on
reducing the tax we will pay
But remember consistency!
Are These Differences Real
The short answer is no...
Once again, just like inventory valuation methods, if Company A and
Company B were exact replicas only one used straight-line and the other
used declining-balance there would be no real change in performance
The only exception being that Company B may have more in tax savings
Disclosures to the Financial Statements
In order to meet full disclosure with regards to depreciation, companies must
include the following in the notes to the nancial statements
The estimates of useful lives of the assets
Consistency Changes
Revision of Estimated Useful Lives
See Pg. 362 for an example of Revision of Estimated Useful Lives --
Know how to recalculate
The Impairment of Plant Assets
Sometimes it becomes necessary to recognize that we will not be able to sell
a certain asset for its realizable value
Possibly due to obsolescence or specialization
At this time it is necessary to write down the value of the asset with the
following entry
Loss resulting from obsolescence ###
Accumulated Depreciation - Equipment ###
This will reect the loss in the book value of the equipment
Homework!
Exercise 8.4 (Declining Balance Method)
Exercise 8.5 (Units-of-Production Method)
Exercise 8.6 (Depreciation Methods)
Problem 8.2 (Determine the Cost of Plant Assets and Depreciation)