Depreciation Formula

Formula to Calculate Depreciation Expense

The formula of Depreciation Expense is used to find how much value of the asset can be deducted as an expense through the income statement. Depreciation may be defined as the decrease in the value of the asset due to wear and tear over a period of time. It is a non-cash expense forming part of profit and loss statements. E.g., depreciation on plant and machinery, furniture and fixture, motor vehicles, and other tangible fixed assets.

There are primarily 4 different formulas to calculate the depreciation amount. Let’s discuss each one of them –

Explanation

Depreciation is an indirect expense charged on tangible fixed assets in a systematic manner to provide the actual cost of an asset over its useful life is proportionate to benefits derived from such assets. The calculation of the depreciation equation requires knowledge of some factors. These factors are:

• Cost of an Asset: Asset cost includes the amount paid to purchase such assets and other related expenses to bring such assets in a usable position such as transportation, installation, taxes paid, etc.
• Residual Value: Residual Value is the amount that is expected to realize at the end of the useful life of an asset.
• Useful life: Expected life of an asset up to which an organization can derive benefits from it.
• Rate of Depreciation: It is the rate at which an organization should reduce the value of an asset in proportionate to benefits derived from such assets.

Depreciation Expense Calculation Examples

Example #1

Company XYZ purchased an asset of $15,000 and expected to realize $1,500 at the end of its useful life. The expected useful life of an asset is 5 years. What is the amount of Depreciation Company should charge in its profit and loss statement?

Solution

Below is data for calculation of the depreciation amount

Therefore, the calculation of Depreciation Amount using Straight-line Method will be as follows,

Using Straight-line Method =  Cost of Asset- Salvage Value/ Useful Life of Asset

• =($15000-$1500)/5

Depreciation Amount will be –

• =$2700

So, the company should charge $2,700 to profit and loss statements and reduce asset value from $2,700 every year.

Example #2

Now let us take an example to understand the diminishing balance method: Mr. X, senior accountant of company ABC Pvt. LTD. The company got a quotation of $ 135,000 for machinery Delta. Company estimate further expense of $ 2,200 on its transportation and installation. Its estimates that asset can be sold for $1,200 at the end of its useful life.

Calculate the rate of depreciation is 15%.Mr. X wants to charge depreciation using the diminishing balance method and wants to know the amount of depreciation it should charge in its profit and loss account. Help Mr. X in calculating the amount of depreciation and closing value of the machine at the end of each year.

Solution

First of all, we will calculate the actual cost of machine delta to the company:

Now, we will calculate the depreciation amount and closing value of the asset using a diminishing balance method:

Therefore, the calculation of Depreciation Amount of 1^st year using the diminishing balance method will be as follows,

Diminishing balance Method = Actual cost of Asset*Rate of depreciation/100

• =137000*20%/100%

Depreciation Amount for 1^st year will be –

• =27400.00

Similarly, we can calculate the depreciation amount for remaining years

Calculation of Closing Value of 1^st year

• =137000-27400
• =109600.00

Similarly, we can calculate the closing value for the remaining years

So after the 10-year book value of the machine is $19030.82.

Example #3

Let us take another example to understand the unit of production method formula. A company beta limited just started it’s business of manufacturing empty bio-degradable water bottles. After doing market research, it comes across a fully automated machine that can produce up to 1,500,000 in its complete life cycle.

The company got a quotation of $ 210,000. It also requires $ 25,000 as installation charges, and the company expected to sell this machine after the end of its usable life for $ 2000. Calculate the amount of Deprecation Company should charge in its books of accounts. Company share with you its annual bottle manufacturing details:

Solution

First of all, we will calculate the actual cost of the machine to the company:

• =$210000+$25000
• =$235000

Now we will calculate the amount of depreciation in each year to be charged using the Unit of Production Method,

Using the Unit of Production Method = (Actual Cost of Machine – Salvage Value)/ Useful Life in the Form of Unit Produced

Here useful life in the form of unit produced is the total unit produced in the year divided by total expected units to be produced.

• =(235000-2000)*(145000/1500000)

Amount of Depreciation in each year to be charged will be –

• =22523.33

Similarly, we can calculate the depreciation amount for remaining year to be charged –

Calculation of Closing Value of 1^st year

• =235000-22523.33
• =212476.67

Similarly, we can calculate the closing value for the remaining years

Relevance and Use

Depreciation expense is an indirect expense and important accounting procedure for an organization to estimate the book value of an asset after its usage during the accounting period. The use of the Deprecation formula is to spread the cost of the asset over its useful life, thereby reducing the huge expense burden in a single year. Following are the importance of depreciation formula in accounting:

• Since depreciation is a non-cash expense, it helps the entity to reduce its tax liabilities.
• At the time of sale of the asset, the company can estimate its profit/loss on the sale of the asset after considering its usage, which is in the form of depreciation.
• Since the purchase amount of assets is huge and charging it in profit and loss account in one shot brings down the profit significantly. But by charging expenses in proportionate to benefits derived burden of expense distributed over the useful life of the asset.

Recommended Articles

This has been a guide to Depreciation Formula. Here we discuss the calculation of depreciation expense using the top 4 methods along with practical examples and downloadable excel template. You can learn more about financial analysis from the following articles –

• Standard Error Formula
• Sum of Year Digits Method of Depreciation
• WDV Method
• Accelerated Depreciation Calculation