Depreciation allocates cost of an asset to the period benefited in line with the Matching concept.
To record depreciation, credit Accumulated Depreciation (contra-asset to PP&E on B/S)
Methods of depreciation
- Straight Line Method (SLM) (HC – SV) × SLM%
(SLM= 1/Useful life)
- Double Declining Balance (HC-Acc Dep) * DDB%
(DDB%= 1/Useful life*2
- Sum of the Years Digit (SYD) | (HC – SV) × SYD%
SYD% = Years Left / Sum of years = n(n+1)/2
- Activity Method (Units of Production) | (HC – SV) × UOP%
UOP% = Hours this year / Total estimated hours
Selection of Depreciation Method:
- Straight Line Method – Use if assets give equal benefit each year (passage of time)
- Accelerated Method – Better matching when asset is more productive in initial years:
- Minimizes obsolescence loss
- Evens out expenses
- Repairs & maintenance rise as CV (carrying value) decreases
- Tax benefit higher in early years (especially DDB for tax)
- Activity Method – Depreciate based on usage, not time