Debitoor Dictionary

Accounting terms explained simply

Depreciation methods - What are depreciation methods?

Depreciation methods allow a business to deduct for products or assets that lose significant value over time

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There are four main methods for determining cost allocation of assets throughout their period of use within a company. Depreciation methods refer to the necessity for businesses to determine the projected loss of value of certain assets over time or based on actual physical usage. This allows for an effective allocation of costs throughout the ‘useful life’ of the asset in the correct period.

Depreciation and time

Depreciation is an important factor to take into account when determining the lifetime value of an asset. Three of the four main depreciation methods are based on time. The fourth is based on the amount of actual physical use of an asset.

Four main methods for determining depreciation

  1. Straight-line depreciation: the simplest and most commonly used depreciation method. It is calculated by subtracting the ‘salvage/scrap value’ (the price it can be sold at when it is no longer of use to the company) of an asset from the original purchase price and then dividing it by the total number of years it is expected to be a useful asset for the company – it’s ‘useful life’. This method results in the same depreciation amount being spread evenly over the course of the asset’s useful life.

  2. Reducing balance depreciation: this method changes the amount of depreciation charged over time. This is most useful for assets that typically lose the most value in earlier years, but then experience a slowing of depreciation later on. Computer equipment is a good example of an asset that would benefit from this method. It is considered an ‘accelerated’ depreciation method.

  3. Sum-of-the-year’s-digits depreciation: a second accelerated method, this also allocates the higher amounts of depreciation to the earlier years of an asset and diminishes over time. This method is determined by adding up the total number of years of the asset’s expected useful life and then figuring out the year in which it currently falls on that scale.

  4. Units of Production Depreciation: the only method that is not based on time, this approach takes into account the amount of activity the asset actually experiences. For example, it allows for a higher depreciation rate during periods of high usage, and a lower rate for periods of low usage or idleness. This method is useful for assets that are greatly affected by physical use or output.

Depreciation in Debitoor

Debitoor allows businesses to mark selected business purchases as assets. It then allows a customisable rate of depreciation depending on the estimated useful life of the asset. A 'Depreciation Profile' is provided for each asset and automatically calculates a Straight Line depreciation.

An example of a 6 year straight line depreciation in Debitoor