There are many different depreciation calculations available to determine the amount of value lost by a business asset over the course of its life span. These calculations are dependent on the method being used to depreciate the asset. Once the method is determined, the depreciation expense for each year can then be reached, an amount that is reported on income statements. The most basic depreciation calculations are based on the two most common methods of depreciation, which are the straight-line method and the declining balance method.
Each year that a business asset is in use, it loses value from its original cost. This loss in value is known as the depreciation expense, and that expense zeroes out from the previous year, unlike the accumulated depreciation amount on the balance sheet, which adds up from year to year. For example, a business asset that depreciates $1,000 US Dollars (USD) every year would have a depreciation expense of $1,000 USD in the first year and every succeeding year of its life, but the accumulated depreciation would be $1,000 USD the first year, then $2,000 USD the second year, and so on.
Of all possible depreciation calculations, the most straightforward is the one associated with the straight-line method of depreciation. The depreciation expense in this method is the same amount each year and is calculated by dividing the original cost of the asset by the time in years of its life span. For example, imagine an asset that has an original cost of $2,000 USD and a life span of five years. This means that the yearly depreciation expense will be $2,000 USD divided by five, or $400 USD each year.
In certain cases, a business may want to expense an asset heavily in the year it is purchased, and that's when the declining balance method of depreciation is useful. Using this method means assigning a fixed rate of depreciation to the balance of the asset's cost. If the asset from the above example was depreciating at a rate of 50 percent each year, the depreciation expense for its first year would be $1,000 USD, or $2,000 USD multiplied by 0.5. For the next year, the balance of the asset's cost would be down to $1,000 USD, which is reached by subtracting the first year depreciation expense of $1,000 USD from the original cost of $2,000 USD. The rate is then applied to this figure for the second year's expense, and this process continues until the asset reaches its salvage cost.
With these two depreciation calculations learned, the double declining method is easy to follow because it is a combination of the two. The rate of depreciation is determined by the straight-line method, which is then doubled and applied using the double declining method. For example, a $2,000 USD asset that has a life span of five years has a 40 percent rate of depreciation, which is reached by dividing $2,000 USD by five. This 40 percent rate is then doubled, yielding 80 percent, which is the rate applied to the original cost using the double declining method.
