METHOD FOR ESTIMATING COST OF DEPRECIATION
There are four main types of depreciation methods used in accounting:
- Straight-Line Depreciation Method: This is the most commonly used method, which assumes that the asset loses an equal amount of its value each year over its useful life. The formula for straight-line depreciation is:
Annual Depreciation Expense = (Initial Cost – Salvage Value) / Useful Life
For example, if a machine cost $100,000, has a useful life of 5 years and a salvage value of $10,000, the annual depreciation expense would be ($100,000 – $10,000) / 5 = $18,000.
- Double-Declining Balance Depreciation Method: This method assumes that the asset loses more of its value in the earlier years of its useful life and less in the later years. The formula for double-declining balance depreciation is:
Annual Depreciation Expense = (2 / Useful Life) * Book Value at Beginning of Year
For example, if the same machine had a book value of $80,000 at the beginning of year 2, the annual depreciation expense for year 2 would be (2 / 5) * $80,000 = $32,000.
- Sum-of-the-Years’-Digits Depreciation Method: This method also assumes that the asset loses more of its value in the earlier years of its useful life and less in the later years. The formula for sum-of-the-years’-digits depreciation is:
Annual Depreciation Expense = (Remaining Useful Life / Sum of the Years’ Digits) * (Initial Cost – Salvage Value)
For example, if the remaining useful life of the machine is 4 years, and the sum of the years’ digits is 1+2+3+4+5 = 15, the annual depreciation expense for year 2 would be (4/15) * ($100,000 – $10,000) = $22,667.
- Units-of-Production Depreciation Method: This method assumes that the asset loses value based on the number of units produced or the amount of usage. The formula for units-of-production depreciation is:
Annual Depreciation Expense = (Cost – Salvage Value) / Estimated Total Production * Actual Production
For example, if the machine is expected to produce 100,000 units over its useful life, and in year 2 it produced 20,000 units, the annual depreciation expense for year 2 would be ($100,000 – $10,000) / 100,000 * 20,000 = $18,000.
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