Different calculations are specified in the accounting rules to provide for depreciation. Two most commonly used methods are the Straight Down Method and Written Down Method. The calculations have different individual suitability and aspects. A company chooses one of these methods to provide depreciation according to their requirement.
The Straight Line Depreciation Method
Straight line basis is a method of calculating depreciation and amortization. Also known as straight line depreciation, it is the simplest way to work out the loss of value of an asset over time. Straight line basis is calculated by dividing the difference between an asset's cost and its expected salvage value by the number of years it is expected to be used. In accounting, many different conventions are designed to match sales and expenses to the period in which they are incurred.
Companies use depreciation for physical assets and amortization for intangible assets such as patents and software. Both conventions are used to expense an asset over a longer period of time, not just in the period it was purchased. In other words, companies can stretch the cost of assets over many different time frames, which lets them benefit from the asset without deducting the full cost from net income.
The Written Down Value Method
Written-down value is a method used to determine a previously purchased asset's current worth and is calculated by subtracting accumulated depreciation or amortization from the asset's original value. The resulting figure will appear on the company's balance sheet.
Written Down Value method is a depreciation technique that applies a constant rate of depreciation to the net book value of assets each year, thereby recognizing more depreciation expenses in the early years of the life of the asset and less depreciation in the later years of the life of the asset. In short, this method accelerates the recognition of depreciation expenses systematically and helps businesses recognize more depreciation in the early years. It is also known as Diminishing Balance Method or Declining Balance Method.
The Formula to Calculate Annual Depreciation As Per Straight Line Method
With the straight line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, subtracting its salvage value by the useful life of the asset.
The Straight Line Calculation Steps Are
Determine the cost of the asset.
Subtract the estimated salvage value of the asset from the cost of the asset to get the total depreciable amount.
Determine the useful life of the asset.
Divide the sum of step 2 by the number obtained in Step 3 to get the annual depreciation amount.
The Straight Line Depreciation Formula for an Asset is as Follows
Annual Depreciation Expense = (Cost of the asset – Salvage value)/ Useful life of the asset.
Cost of the asset is the purchase price of the asset
Salvage value is the value of the asset at the end of its useful life
The useful life of asset represents the number of periods/years in which the asset is expected to be used by the company
Straight Line Method And Written Down – A Comparative Analysis
In accounting glossary, the term depreciation is often used, for writing off the value of the asset over its useful life. It is nothing but the decrease in the value of the fixed asset because of continuous use, the passage of time and technological obsolescence. There are nine different methods of calculating the depreciation of assets out of which the Straight-Line Method and written down value method is widely used. In the Straight-Line Method (SLM), an equal amount of depreciation is written off every year. Conversely, in the written down value method (WDV), there is a fixed rate of depreciation which is applied to the opening balance of the asset every year.
Further, The Analysis is Illustrated in The Following Points
A method of depreciation in which the cost of the asset is spread uniformly over its lifespan by writing off a fixed amount every year is the SLM method. While a fixed rate of depreciation is charged on the book value of the asset over its useful life in the WDV method.
To calculate depreciation, SLM applies to the original cost and WDV method applies to the written down value of the asset.
Annual depreciation charge remains fixed during the useful life in case of SLM. In the WDV method, it reduces every year.
The value of the asset is completely written off in SLM but the WDV value is not completely written off.
Amount of depreciation in SLM is initially lower. In WDV, it is initially higher.
Impact of repairs and depreciation on P&L A/C is on an increasing trend in SLM while the impact remains constant in WDV.
SLM appropriate for assets with negligible repairs and maintenance like leases, copyright. In WDV assets whose repairs increase as they get older like machinery, vehicles etc.
To summarize, in a straight-line method, depreciation is calculated on the original cost. On the other hand, in the written down value method, the calculation of depreciation is based on the written down value of the asset. The annual depreciation charge in SLM remains fixed during the life of the asset.