Depreciation cost is considered a business loss because it indicates a decline in the value of equipment, business properties and other related assets as well. These are natural and unavoidable business costs, because depreciation costs are relative to the time spent on the utilization of a certain business asset. However, businessmen need not worry, because there are ways to calculate depreciation. The techniques are explained below.
1. The Straight Line Depreciation Technique. This technique is, by far, the simplest of all the methods of gauging depreciation. The formula for this technique is simply to divide the cost or the value of the item when it was purchased divided by the life expectancy. For example, office equipment costs $990.50 and its life expectancy is 5 years. The calculation would be $990.50/5 = $198.10. This means that the annual depreciation cost would be $198.10.
However, the calculation would be different if there is a salvage value included. A salvage value is a projected worth of an asset at the conclusion of its useful life. The formula for this technique including a salvage value is the original value of the item when it was purchased minus the salvage value. The difference of the value will then be divided by the life expectancy. Looking back at the example earlier mentioned, if we include a salvage value of $50.25, the calculation would be as follows: ($990.50 - $50.25)/5 = $188.05.
2. The Double Declining Balance Depreciation Technique. This technique uses a factor, which means that the depreciation is higher at the beginning of an assets' useful life. For example, as this is where this technique is usually applied, newer cars depreciate more than older cars. The factor is the ratio of the asset that would be depreciated multiplied by an accelerator. The most common accelerator is 200% of the value or twice its worth. A sample table below is shown - using as an example, software worth $500 with life expectancy of 3 years. The factor is 2(1/3) = 0.67
Year Asset Value Depreciation Calculation Depreciation Cost
1 $500 500*.67 $335
2 $335 335*.67 $224.45
3 $224.45 224.45*.67 $150.38
3. The Sum of the Years' Digits Technique. The sum of the years' digits technique sums up all the number of years of the useful life of an asset. For example, an asset with a life expectancy of 3 years would mean 1+2+3 = 6. The number of years of the useful life of an asset would then be divided by the accumulated sum of the digits. The quotient is then multiplied by the asset value. A sample table is shown - using an office machine worth $1,500 with useful life of 4 years (1+2+3+4 = 10).
Year Digit Calculation Depreciation Calculation Depreciation Cost
1 4/10 = .40 $1,500*.40 $600
2 3/10 = .30 $1,500*.30 $450
3 2/10 = .20 $1,500*.20 $300
4 1/10 = .10 $1,500*.10 $150
Calculating depreciation is important in businesses not only because it helps business entities predict their losses, but as a tool for appraising such business assets. Many accountants, consultants and other business professionals calculate depreciation for accounting, auditing and assessing purpose.