How to calculate depreciation and accumulated depreciation?

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In this section, I will show you how to calculate depreciation using and incorporated this into the financial statement.

As we learnt that Non current Assets are for use in the business and not for the purpose of resales, but over time, the assets will depreciate due to few factors like:-
1 wear and tear
2 usage
3obselences.

I will introduce two methods of depreciation, -- reducing balance method and straight line method.

Straight line method

The non current assets will have equal amount of depreciation over its expected useful life


Depreciation = Original cost price - Scraped value
                                 Estimated useful life

or 

Depreciation =Rate of depreciation x [Original  cost of the Non Current Asset - scraped value]

Example 1
Cost of furniture = $10000
Scraped value = $1000
Estimated useful life= 5 years

Calculate the depreciation for 1st and 2nd year.

Depreciation =10000-1000
                               5
                      =$1800

Depreciation for 1st and 2nd year will have the same depreciation of $1800 as it is the straight line method.  Equal amount of depreciation every year.

Reducing balance method

This method assumed that a higher amount will be recorded in the earlier year and a lower amount will be recorded in the later year.  This method assumes that the non current assets provides more benefit in the earlier year than later years, eg motor vehicle and machinery.

Depreciation = Rate of depreciation x Net book value
[net book value = original cost of the non current assets- accumulated depreciation]

Example 2
Cost of motor vehicle =$150000
Rate of depreciation =20% per annum

Depreciation at the end of year 1 = 20% x150000=$30000

Accumulated depreciation at the end of year 1 = 0 + $30000=$30000 {as there is no depreciation earlier}

Depreciation at the end of year 2 = 20% x [150000-30000]=$24000

Accumulated depreciation at the end of year 2 = $30000+ $24000=$54000

Depreciation at the end of year 3 = 20% x[150000-54000]=$19200

Accumulated depreciation =$54000+$19200=$73 200

The depreciation highlighted in red has been decreasing over the 3 years.  That explained why this method is known as reducing balance method.


Question for practise 
Shaun bought machinery at cost $400000 on 1 January 2017.  He decided to depreciated the non current assets by using the reducing balance method at 20% per annum.  The accounting year ended on 31 December each year.
Calculate the depreciation for 3 years for shaun and show an extract of the Statement of financial position for the non current assets for the 3 years ending 31 December.

Answer : 

Year 1 : 20% x 400000 = $80000
Year 2 : 20% x (400000-80000) =$64000
Year 3 : 20% x(400000-80000-64000)=$51200

Statement for finanial position as at 31 December 2017
Non current assets                                          cost         accumulated depreciation  Net book value
Machinery                                                     400000         80000                                   320000

Statement for finanial position as at 31 December 2018
Non current assets                                          cost         accumulated depreciation  Net book value
Machinery                                                     400000        1440000                                   256000


tatement for finanial position as at 31 December 2019
Non current assets                                          cost         accumulated depreciation  Net book value
Machinery                                                     400000        195200                                   204800


By checking on these 2 methods of depreciation, think of what will happen to the profit for the business if the straight line method is used instead of the reducing balance method?



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