What is Depreciation
Depreciation is an accounting practice used to spread the cost of a tangible or physical asset over its
useful life. Depreciation represents how much of the asset's value has been used up in any given time
period. Companies depreciate assets for both tax and accounting purposes and have several different
methods to choose from.
Types of Depreciation
There are a number of methods that you can use to depreciate capital assets. They include:
Straight Line Method
Sinking Fund Formula
Declining Balance Method
Double Declining Balance (DDB) Method
Sum of the Years’ Digits (SYD) Method
Service Output Method
We've highlighted some of the basic principles of each method below, along with examples to show
how they're calculated.
Straight-Line
The straight-line method is the most basic way to record depreciation. It reports an equal depreciation
expense each year throughout the entire useful life of the asset until the asset is depreciated down to its
salvage value.
Where:
d = Depreciation Expense = annual cost of depreciation
𝐷𝑛 = depreciation up to age n years
𝐶𝑜 = Cost of Asset = original cost
𝐶𝐿 = Salvage Value = value at the end of life, scrap value
𝐶𝑛 = book value at the end of n years
L = Useful Life = useful life of a property in years
Sinking Fund Formula
The sinking fund formula is used to calculate the periodic payments needed to achieve a
future financial goal, such as paying off a debt or accumulating a specific amount of money.
It involves determining the regular payments required to grow a sum of money to a desired
future value, assuming a fixed interest rate.
The formula for calculating the periodic payment P required to reach a future value F in n
periods, with an interest rate r per period, is given by:
Where:
P = Periodic payment (the amount to be contributed regularly)
F = Future value (the target amount to be achieved)
r = Interest rate per period (expressed as a decimal)
n = Number of periods (the total number of payment periods)
Declining Balance Method
The declining balance method is an accelerated depreciation method that begins with the asset's book,
rather than salvage, value. Because an asset's carrying value is higher in earlier years (before it has
begun to be depreciated), the same percentage causes a larger depreciation expense amount in earlier
years, then declines each year thereafter. This is the formula:
Book Value at Beginning of Period = This represents the
remaining value of the asset at the start of the period.
Depreciation Rate = This is the rate at which the asset's value is
depreciated each period, expressed as a percentage.
Double Declining Balance (DDB) Method
The double-declining balance (DDB) method is an even more
accelerated depreciation method. It doubles the (1/Useful Life)
multiplier, making it essentially twice as fast as the declining
balance method.
Sum of the Years’ Digits (SYD) Method
The sum-of-the-years' digits (SYD) method also allows for accelerated depreciation. You start by
combining all the digits of the expected life of the asset.
dn = depreciation charge during the nth year
dn = (𝑟𝑒𝑣𝑒𝑟𝑠𝑒 𝑑𝑖𝑔𝑖𝑡 /𝑠𝑢𝑚 of digits) x (𝐶𝑜 − 𝐶𝐿)
dn = (depreciation factor) x (total depreciation)
Years = L/2 x (L +1)
Service-Output Method
The Service-Output Method is a depreciation technique that allocates depreciation expense based on
the actual service or output provided by the asset during its useful life. This method is commonly used
for assets whose productivity or output can be easily measured.
Let T = total units of output up to the end of life
𝑄𝑛 = total number of units of output during the nth year
Sample problems:
Straight Line Method - Universidad de Sta. Isabel ( author )
1. A machine has an initial cost of P150,000.00 and a salvage value of P20,000.00 after 12
years. What is the book value after 6 years using straight line depreciation?
Solution:
Annual depreciation = 150,000−20,000 12 = P10,833.33
Book Value after 6 years = 150, 000 -(6)(10833.33) = P85,000.00
2. An engineer bought an equipment for P1,000,000.00. He spent an additional amount of P300,000.00
for installation and other expenses. The salvage value is 15% of the first cost. If the book value at the
end of 7 years will be P333,125 using straight line method of depreciation, compute the useful life of
the equipment in years.
Solution:
Fixed Cost = 1,000,000 + 300,000 = P1,300,000.00
Salvage Cost = (0.15)(1,300,000) = P195,000
Annual Depreciration = 1,300,000 - 195,000 = 1,150,000
C7 ( book value ) = First cost -Total Depreciation
333,125 = 1,300,000 - (1,150,00)(7)/n
n = 8.33 = 8 years
Sinking Fund Formula - Khan Academy ( Author )
1. Suppose an individual wants to save up $20,000 for a down payment on a house in 8 years.
They plan to deposit money into a sinking fund annually, with an annual interest rate of 8%.
Let's calculate the annual deposit needed.
Given:
Co = $20,000
Number of periods (n) = 8 years
Interest rate per period (r) = 8% = 0.08
Solution:
d = 20,000 / (1 + 0.08 )^8 -1 / 0.08
d = $1880.3
2. Let's say a company wants to accumulate $50,000 in 5 years to replace a piece of
machinery. They plan to deposit money into a sinking fund annually, with an annual interest
rate of 6%. Using the sinking fund formula, we can calculate the annual deposit required.
Given:
Co = $50,000
Number of periods (n) = 5 years
Interest rate per period ® = 6% = 0.06
Solution:
d = 50,000 / (1 + 0.06 )^5 -1 / 0.06
d = $8869.8
Declining Balance Method and Double Declining Balance (DDB) Method
- Wallstreetmojo Team ( Author )
1. Suppose a business has bought a machine for $ 100,000. They have estimated the
machine’s useful life to be eight years, with a salvage value of $ 11,000.
Now, as per the straight-line method of depreciation:
Cost of the asset = $ 100,000
Salvage Value = $ 11,000
The useful life of the asset = 8 years
Depreciation rate = 1/useful life *100 = (1/8) * 100 = 12.5%
Double-declining balance formula = 2 X Cost of the asset X Depreciation rate.
Here, it will be 2 x 12.5% = 25%
Year 1 Depreciation = $100000 X 25% = $25,000
Year 2 Depreciation = $75,000 x 25% = $18,750
Sum of the Years’ Digits (SYD) Method - ALICIA TUOVILA (Author)
1. an asset with a five-year life would have a base of the sum of the digits one through five, or
1 + 2 + 3 + 4 + 5 = 15. In the first year, 5/15 of the depreciable base would be depreciated. In
the second year, 4/15 of the depreciable base would be depreciated. This continues until year
five when the remaining 1/15 of the base is depreciated. The depreciable base in all of these
cases is the purchase price minus the salvage value, or $4,000 in the example we've been
using.
Year Remaining Years Depreciable Fraction Depreciation Expense
1 5 5/15 $1,333.33
2 4 4/15 $1,066.67
3 3 3/15 $800.00
4 2 2/15 $533.33
5 1 1/15 $266.67
Service Output Method - MechBix ( Author )
The first cost of a road lying machine is Rs.80,00,000. Its salvage value after five years is Rs.50,000.
The length of road that can be laid by the machine during its lifetime is 75,000km. In its 3rd year of
operation, the length of road laid is 2,000km. Find the depreciation of the equipment for that year.
Given data
Purchase price, P = ₹. 80,00,000
Salvage value, F = ₹. 50,000
X = 75,000km
x = 2,000km
Year in Depreciation Depreciation During the Book Value at the End
Year Reverse Order Factor Year of the Year
1 5 106.00 2,12,000 77,88,000
2 4 106.00 2,12,000 77,88,000
3 3 106.00 2,12,000 77,88,000
4 2 106.00 2,12,000 77,88,000
5 1 106.00 2,12,000 77,88,000
https://www.investopedia.com/terms/d/depreciation.asp - Depreciation: Definition and Types, With
Calculation Examples
https://www.educba.com/sinking-fund-formula/#Sinking%20Fund%20Formula - EDUCBA
| BLOG
https://www.krayonnz.com/user/doubts/detail/61925f92a355c70043d955b6/what-is-Service-
Output-Method-of-Depreciation-in-Engineering-Economics
https://www.cliffsnotes.com/study-notes/5700497 -
SOLVED-PROBLEMS-Straight-Line-Method-of-Depreciation
https://www.wallstreetmojo.com/double-declining-balance-method/ - Double Declining Balance
Method
https://www.mechbix.com/2020/04/service-output-method-of-depreciation.html
