Methods Of Depreciation SS1 Financial Accounting Lesson Note

METHODS OF PROVIDING FOR DEPRECIATION

1. Straight-line Method
2. Reducing Balance Method (or Diminishing Balance Method)
3. Sum of the year’s digit
4. Revaluation Method
5. Depletion Unit Method

Other less common methods include:

6. Sinking Fund Method
7. Insurance Policy Method
8. Annuity Method etc.

STRAIGHT LINE METHOD

Under this method, an equal amount is charged for depreciation yearly throughout the usage of an asset.

Formula = Cost Scrap Value

                      No. of years

ADVANTAGES OF THE STRAIGHT-LINE METHOD

1. It is simple (or easy) to calculate
2. It is widely used
3. It is time-oriented
4. It is judicially recommended – Edwards v. Sauntons Hotels

DISADVANTAGES OF THE STRAIGHT-LINE METHOD

1. It is not suitable (or ideal) for all types of fixed assets. For example, it cannot be used for loose tools
2. It is not scientific as it does not take the efficiency of the asset into consideration
3. The assumption of equal depreciation per year is unrealistic.

REDUCING BALANCE METHOD (or DIMINISHING BALANCE METHOD)

Under this method, a fixed percentage is written off the reducing (or diminishing) balance of the asset yearly. This method charges higher depreciation in the early years of the asset and lowers in the later years

The depreciation rate (%) to be applied is computed using the formula below:

           S

Depreciation rate (%) = 1- C

where:

n = No. of years

s = Scrap value

c = Cost

Advantages Of The Diminishing Balance Method 

1. It is widely used.
2. Depreciation is more scientifically provided for.
3. It recognizes the efficiency of an asset by charging higher amounts in the early years and lower amounts in the later years.
4. Higher depreciation amounts and low maintenance costs in the early years even out with low depreciation amounts and higher maintenance costs in the later years

Disadvantages Of The Diminishing Balance Method 

1. Calculating the rate of depreciation may be difficult
2. It is not ideal for all fixed assets. For example, it cannot be used for loose tools.

REVALUATION METHOD

Under this method the asset is revalued each year, any difference being charged to the profit and loss account.

This method is good for assets which cannot be easily depreciated because of their nature e.g. loose tools (i.e. bolts, nuts, hammers, chisel, screws) livestock, farm crops/plantations etc. The value of the assets at the beginning and end of the year will be estimated and used in the calculation of the depreciation.

Advantages Of The Revaluation Method

1. It is suitable (or ideal) for loose tools, livestock etc.

Disadvantages Of The Revaluation Method

1. It cannot be used for all classes of assets.
2. Revaluation of assets every year may be cumbersome