Depreciation Calculation – Straight Line and Accelerated Methods of Calculating Depreciation Expenses

Famous for its tax benefits, depreciation is the cost of assets being used in an accounting period to generate the revenue. With the Modified Accelerated Cost System used by the federal tax structure, diminishing balance and straight line method are the options available for the taxpayer to calculate depreciation.

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Depreciation Calculation - Different Methods

Depreciation calculation is an important aspect of accounting as it is used for both financial and taxation purpose. There are n number of methods for calculating depreciation. However, every country has its own accounting standard and taxation system, which proposes the method of depreciation to be used for every asset and accordingly, your asset must be depreciated and brought down to its book value.According to the basic fundamentals of depreciation accounting, an asset starts depreciating from the moment it is put to use and it is necessary to charge depreciation to match the revenue with its cost. The two major methods of depreciation calculation are the straight line method and the accelerated method. In the straight line method, depreciation is charged at a fixed rate on the historical or cost price of the asset. In this case, the difference between the original cost price and the residual value of the asset at the end of its estimated life is apportioned equally during the lifetime of the asset. For eg; If the cost price of the asset is 40000, estimated life is 5 years and residual value is 2000 then annual depreciation =( 40000 - 2000) / 5.The straight line method is the easiest and most commonly used, especially when you have to depreciate your asset completely without leaving any residual value. One of the most preferred method, proposed by the accounting standards and the federal tax system, diminishing balance method or reducing balance method is a famous accelerated depreciation method. In this case, your asset can never be depreciated completely and you will always find a residual value at the end of the life of the asset. This method is best suited for assets, which can guarantee a scrap value at the end of their life. Unlike the straight line method where the cost price is the base, in diminishing balance method your depreciation calculation is done every year on the book value. The annual depreciation is equal to the book value multiplied by the specific depreciation rate.

Depreciation Tables - Easy Guide for Calculation

The US tax structure uses the Modified Accelerated Cost Recovery System (MACRS), in which the diminishing balance method of depreciation is prominent. However, a taxpayer has the option of choosing the straight line method over the accelerated methods, subject to certain limitations. Under MACRS, the taxpayers use depreciation tables, to calculate depreciation for different class of assets. Basically the assets are classified into two parts depending on the nature of the asset and the business in which the asset is used. However, when the type of an asset is identified and applied, it takes precedence over the nature of the business. Each class is further divided into three parts viz. General Depreciation System, Alternative Depreciation System and Class Life.For example, MACRS Table A-1 is generally used for non real estate property, while MACRS Table A-14 is used for all farm properties in the 15 to 20 year class. You need not be an intellectual or a genius to understand the depreciation tables. With a little bit of research, any taxpayer can easily identify the class of their business assets and apply it accordingly.

Depreciation and Amortization - Similar, Yet Different Concepts.

Depreciation and amortization are many times used as similar words. A layman thinks that theses two words can be used interchangeably, and even though the basic concept behind depreciation and amortization is one and the same, there is a major difference between both this words. Depreciation is used specifically for tangible assets, while amortization refers to depreciating or more commonly known as amortizing an intangible asset.For example, if a machine is created with a patent of 15 years, then this machine will be amortized with an estimated life of 15 years and many a times zero scrap value. In the end, an entrepreneur must always remember that, though depreciation, amortization, and depletion are often used interchangeably, they are three different concepts with different results.