Depreciation methods

🛠️ Depreciation Methods – Complete Guide

Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. It helps match the asset’s cost with the revenue it generates over time.

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📘 Why Is Depreciation Important?

• Reflects wear and tear of assets

• Reduces book value over time

• Affects profit, tax liability, and cash flow

• Required by accounting standards (IFRS, GAAP, Ind AS)

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🧮 Popular Depreciation Methods

Method	Description	When to Use
Straight-Line (SLM)	Same amount each year	Uniform asset usage
Declining Balance (WDV)	Higher depreciation in early years	Assets lose value quickly
Units of Production	Based on actual usage/output	Variable usage (e.g., machinery, vehicles)
Sum-of-the-Years-Digits (SYD)	Accelerated method	Fast obsolescence

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1️⃣ Straight-Line Method (SLM)

Formula:

$$\text{Depreciation per Year} = \frac{\text{Cost} - \text{Residual Value}}{\text{Useful Life}}$$

Example:

• Asset Cost = ₹1,00,000

• Residual Value = ₹10,000

• Life = 5 years

$$\text{Depreciation} = \frac{1,00,000 - 10,000}{5} = ₹18,000/year$$

✔️ Simple, predictable
❌ Doesn’t match usage for all asset types

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2️⃣ Written Down Value (WDV) / Declining Balance Method

Formula:

$$\text{Depreciation} = \text{Opening Book Value} \times \text{Depreciation Rate} \%$$

Depreciation reduces every year because it's charged on a reducing balance.

✔️ Matches actual asset usage (common in India for tax)
❌ Book value never reaches zero

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3️⃣ Units of Production Method

Formula:

$$\text{Depreciation per Unit} = \frac{\text{Cost} - \text{Residual Value}}{\text{Total Estimated Units}}$$

Multiply by actual units produced per year.

✔️ Ideal for machinery, vehicles
❌ Complex tracking needed

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4️⃣ Sum-of-the-Years-Digits (SYD)

Accelerated method using sum of years as denominator.

For 5 years: SYD = 5+4+3+2+1 = 15

Year 1 depreciation =

$$\frac{5}{15} \times (Cost - Residual)$$

✔️ Higher depreciation early
❌ Rarely used today

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5️⃣ MACRS (US Only)

Modified Accelerated Cost Recovery System – Used in the U.S. for tax depreciation.

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🧾 Journal Entry (All Methods)

Depreciation Expense A/c ............. Dr  
     To Accumulated Depreciation A/c

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📊 Impact on Financial Statements

Statement	Impact
Income Statement	Depreciation Expense ↓ Net Profit
Balance Sheet	Asset Value ↓ via Accumulated Depreciation
Cash Flow	Non-cash expense → added back in Operating Activities

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✅ Choosing the Right Method

Asset Type	Ideal Method
Buildings	SLM
Vehicles, machinery	WDV or Units of Production
Computers, electronics	WDV or SYD
Assets with consistent use	SLM
Assets with fluctuating use	Units of Production

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⚖️ Standards & Regulations

Country	Standard	Notes
IFRS	IAS 16	Method must reflect usage pattern
US GAAP	ASC 360	Multiple methods allowed
India	Ind AS 16 / Companies Act 2013	Prescribed useful life for assets