depreciation
Over time fixed assets depreciate which means their value gradually decreases. This decrease in value needs to be shown on the balance sheet, otherwise the net worth of the company would not be accurate. In order to do this there are a few different depreciation methods that can be applied.
Straight Line Method
The straight line method is the simplest way to depreciate an asset, though this simplicity makes it not the most accurate method as it is unrealistic an asset will depreciate by the same value every year.
Annual Depreciation = Cost of fixed asset - Residual value Lifespan of fixed asset
Cost of fixed asset: Purchase price of the asset.
Lifespan: Expected amount of time the firm will use the fixed asset before it needs to be replaced.
Residual value: Expected selling value of the asset at the end of the life of the lifespan of the asset (aka scrap value).
Reducing Balance Method
The reducing balance method of depreciation takes a little bit more calculation but is a more accurate representation of depreciation for an asset.
Straight Line Method
The straight line method is the simplest way to depreciate an asset, though this simplicity makes it not the most accurate method as it is unrealistic an asset will depreciate by the same value every year.
Annual Depreciation = Cost of fixed asset - Residual value Lifespan of fixed asset
Cost of fixed asset: Purchase price of the asset.
Lifespan: Expected amount of time the firm will use the fixed asset before it needs to be replaced.
Residual value: Expected selling value of the asset at the end of the life of the lifespan of the asset (aka scrap value).
Reducing Balance Method
The reducing balance method of depreciation takes a little bit more calculation but is a more accurate representation of depreciation for an asset.
- Depreciation = Annual Depreciation Rate * Book Value for previous year
- This depreciation # is then subtracted from the book value of the previous year to get book value of the current year.