Depreciation -Definition,Examples,Formulas,Factors

Definition of Depreciation in Accounting

In accounting terms, depreciation is defined as the reduction of the recorded cost of a fixed asset in a systematic manner until the value of the asset in a particular period,Depreciation is an indirect expense charged on tangible fixed assets.

Examples of tangible fixed assets are-

• business premises,
• equipment,
• furniture and fixture,
• inventory,
• machinery. 

To provide the actual cost of an asset over its useful life in a systematic manner is proportionate to the benefits derived from such asset. Depreciation can be defined as the decrease in the value of an asset due to wear and tear over a period of time.

Calculation of Depreciation

There are mainly 4 different formulas to calculate the depreciation amount.Those are discus below-

1. Straight Line Depreciation Method
2. Diminishing Balance Method
3. Unit of Product Method
4. Double Declining Balance Method

Formulas to Calculate Depreciation

 

Straight Line Depreciation Method = `"(Cost of an Asset – Residual Value)"/"Useful life of an Asset"`

Diminishing Balance Method = `"(Cost of an Asset x 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 x `"(Beginning Value – Salvage Value)"/"Useful life"`

Factors of Depreciation

The calculation of the depreciation equation requires knowledge of some factors. These factors are:

• Residual Value 
• Rate of Depreciation
• Asset's Cost
• Useful life.

Residual Value

 The residual value, also known as salvage value, is the estimated value of a fixed asset at the end of its lease term or useful life.for example- You want a car on lease for 7 lakhs for a period of 3 years (36 months) and suppose the car depreciates 50% after 3 years. Then, the balance value of the car at the end of the lease will be ₹3.5 lakh and the monthly lease payment will be calculated using this amount.

Rate of Depreciation

It is the rate at which an organization must reduce the value of an asset in proportion to the profits derived from such assets.

Asset's Cost

This includes the money involved in buying assets and using them for their own purposes. For example, the cost of a machine includes its purchase cost, transportation expenses and installation charges.

Useful life

The useful life of an asset is an accounting estimate of the number of times it is likely to remain in service for the purpose of cost-effective revenue generation.