Depreciation Methods: Units of Production and Reducing Balance. from businessbankingcoach.com in association with

Transcription

1 Depreciation Methods: Units of Production and Reducing Balance from businessbankingcoach.com in association with

2 Last time the topic of the presentation was the straight-line method of calculating depreciation.

3 In this presentation we ll cover the other two main methods that are much less commonly used.

4 Firstly, the units of production method.

5 This is especially suited to the depreciation of equipment that is used in a manufacturing process.

6 .since the amount of depreciation that is charged in an accounting period is directly related to the output of the machinery or equipment during that time.

7 There are three components to the calculation; the cost of the equipment

8 its expected total unit output over its useful life any residual value the equipment may have at the end of its useful life

9 Let s use the same equipment that we used in the straight-line example to illustrate how the units of production method works.

10 If you recall, the equipment cost 100,000 and had an estimated residual value of 20,000, leaving us with a depreciable value of 80,000.

11 But with the units of production method, the useful life is determined by units produced by the equipment rather than by time, as was the case in our straight-line method example.

12 So, let s say that the directors of the business estimate that the equipment will produce 40,000 units before it has to be scrapped.

13 We can now calculate what the depreciation amount will be for each unit produced, using the following formula;

14 The depreciable value 80,000 = 2 40,000 estimated total units of production

15 This means that each time the equipment produces one unit, there will be depreciation of 2 accounted for as an operating expense.

16 At the end of the accounting period, the total number of units produced during the year is multiplied by 2 to arrive at the total amount of depreciation for that piece of equipment for that year.

17 Secondly, the other method of calculating depreciation is called the reducing balance method

18 The reducing balance method is suited to those assets that quickly become technologically obsolete.

19 .or which use a greater proportion of their productive value in the early years of ownership.

20 In this method the directors of the business select a percentage of the value of the asset that will be applied in each accounting period to calculate depreciation.

21 The three components of this calculation are; the cost of the asset

22 its expected useful life measured by time a percentage of the value that will be applied annually to depreciate the asset over its expected useful life

23 Going back again to our example of a piece of equipment costing 100,000 and with an expected useful life of 5 years.

24 ..let s say that the directors decide to depreciate it at 50% per financial year and, to keep things simple, let s also say that the business acquired the equipment on the first day of the financial year.

25 In the first year, the amount of depreciation would be calculated as follows;

26 The initial cost of 100,000 multiplied by 50%, which results in a depreciation figure for the first year of 50,000.

27 So, it looks like this. Depreciable value of asset Depreciation percentage Amount of depreciation Depreciated value of asset Year 1 100,000 50% 50,000 50,000

28 In the second year, the initial cost of the equipment is not used in the calculation. Instead the reduced balance of 50,000 is used as the base figure.

29 The calculation of depreciation is then; The reduced balance of 50,000 multiplied by 50%, which gives us a depreciation figure for the second year of 25,000.

30 So now, it looks like this. Depreciable value of asset Depreciation percentage Amount of depreciation Depreciated value of asset Year 1 100,000 50% 50,000 50,000 Year 2 50,000 50% 25,000 25,000

31 In the following year, that reduced balance of 25,000 is used as the base figure in the calculation.

32 That same process then continues until the equipment reaches the end of its useful life or is disposed of.

33 Like this. Depreciable value of asset Depreciation percentage Amount of depreciation Depreciated value of asset Year 1 100,000 50% 50,000 50,000 Year 2 50,000 50% 25,000 25,000 Year 3 25,000 50% 12,500 12,500 Year 4 12,500 50% 6,250 6,250 Year 5 6,250 50% 3,125 3,125

34 Whatever balance is left at the end of the useful life is deemed to be the equipment s residual value.

35 We do hope that you enjoyed this presentation. For more commercial and business banking content, please visit our website at where you can subscribe to our blog, listen to our podcasts or view and download our other Slideshare presentations. If you have any questions about this presentation or any of our other content, please send us an at