Depreciation Formula

Article byWallstreetmojo Team
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

Formula to Calculate Depreciation Expense

The formula of Depreciation Expense is used to find how much asset value can be deducted as an expense through the income statement. Depreciation may be defined as the decrease in the asset’s value due to wear and tear over 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 assetsTangible Fixed AssetsTangible assets are assets with significant value and are available in physical form. It means any asset that can be touched and felt could be labeled a tangible one with a long-term valuation.read more.

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

Straight Line Depreciation Method = (Cost of an Asset – Residual Value)/Useful life of an Asset.
Diminishing Balance Method = (Cost of an Asset * Rate of Depreciation/100)
Unit of Product Method =(Cost of an Asset – Salvage Value)/ Useful life in the form of Units Produced.
Double Declining Balance Method = 2*(Beginning Value – Salvage Value)/Useful life
Depreciation-Formula

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Explanation

Depreciation is an indirect expense systematically charged on tangible fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more to provide the actual cost of an asset over its useful life is proportional to benefits derived from such assets. The calculation of the depreciation equation requires knowledge of some factors. These factors are:

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Depreciation Expense Calculation Examples

You can download this Depreciation Formula Excel Template here – Depreciation Formula Excel Template

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 five years. What amount of Depreciation should the Company charge in its profit and loss statement?

Solution

Below is data for calculation of the depreciation amount

  • Cost of Asset: $15,000
  • Salvage Value: $1,500
  • Useful Life of Asset: 5

Therefore, the calculation of Depreciation Amount using Straight-line MethodStraight-line MethodStraight Line Depreciation Method is one of the most popular methods of depreciation where the asset uniformly depreciates over its useful life and the cost of the asset is evenly spread over its useful and functional life. read more will be as follows,

Depreciation Formula Example 1.1

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

  • =($15000-$1500)/5

Depreciation Amount will be –

Depreciation Formula Example 1.2
  • =$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 Delta machinery. Company estimated a further expense of $ 2,200 on its transportation and installation. It is estimated that the 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 accountProfit And Loss AccountThe Profit & Loss account, also known as the Income statement, is a financial statement that summarizes an organization's revenue and costs incurred during the financial period and is indicative of the company's financial performance by showing whether the company made a profit or incurred losses during that period.read more. Help Mr. X calculate the 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:

Depreciation Formula Example 1.3

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

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

Depreciation Formula Example 2

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

  • =137000*20%/100%

Depreciation Amount for 1st year will be –

Example 2.1
  • =27400.00

Similarly, we can calculate the depreciation amount for remaining years

Example 2.2

Calculation of Closing Value of 1st year

Depreciation Formula Example 2.3
  • =137000-27400
  • =109600.00

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

Example 2.4

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 called beta limited just started its business of manufacturing empty biodegradable water bottles. After 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 the Company should charge in its books of accounts. Company share with you its annual bottle manufacturing details:

YearBottle Manufactured
1145000
2153000
3120000
4165000
5134000
6143000
7154000
8193000
9145000
10148000

Solution

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

Example 3.1
  • =$210000+$25000
  • =$235000

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

Depreciation Formula Example 3.2

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 –

Depreciation Formula Example 3.3
  • =22523.33

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

Example 3.4

Calculation of Closing Value of 1st year

Example 3.5
  • =235000-22523.33
  • =212476.67

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

Example 3.6

Relevance and Use

Depreciation is an indirect expense and an important accounting procedureImportant Accounting ProcedureThe accounting procedure is the process of standardized nature that performs a specific accounting function designed to incorporate better risk management policies to complete these functions efficiently. It includes billings, invoices to suppliers, bank reconciliation, requiring comprehensive and streamlined procedures.read more for an organization to estimate the book value of an asset after its usage during the accounting period. The Depreciation formula uses the Deprecation formula to spread the asset’s cost over its useful life, thereby reducing the huge expense burden in a single year. Following are the importance of the depreciation formula in accounting:

  • Since depreciation is a non-cash expense, it helps 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, charging it in a profit and loss account in one shot significantly decreases the profit. But by charging expenses proportionate to benefits, the expense burden is distributed over the useful life of the asset.

Recommended Articles

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

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