What are the different methods of depreciation?
submitted by Shahid

hankenstein

There are lots, but the Big 4 you'll want to know are:

Straight-Line - total depreciation is divided evenly each year

Double Declining Balance - double the depreciation rate of straight-line, use that each year

Units of Production - depreciate based on actual use of the asset, rather than the time it's owned

Sum of the Year's Digits - the worst named and most complicated method

Jubilant Jerome

The most common is straight-line. It's easiest too. You just divide the asset's cost by its useful years. This is nice because it's the same amount every year. You've got a used generator that you think will get you 5 good years of service. You paid $2,000 for it. $2,000 / 5 years = 400 of depreciation per year. Simple.

You've also got double declining balance, which is double the rate you'd use for straight-line. If you've got 5 years of useful life to expect from your asset, then your straight-line depreciation rate is 20%. For double declining, just double that rate to 40%. Each year you depreciate 40% of the remaining value.

frillious

Straight-line is the go-to standard. It spreads the cost evenly each year. Declining balance depreciates more in the early years. There's also units of production, which is based on how much you actually use the asset. That could be hours on a machine, like a skid steer, or how many units a piece of factory equipment can produce.

Awjit

There's a method called double declining balance that's not as common. It means you take more depreciation at first. Like if you buy something for $10,000, you might write off 40% in the first year instead of just 20%. It helps to save taxes early on.

Yerry

I like Units of Production, because it reflects the actual use on the equipment. Sometimes equipment gets stored, so this might make a more accurate reflection of its value. Or, if the equipment is a vehicle, it's not going to get the same amount of use every year. It helps to depreciate as it's used.

Let's say you want to use Units of Production depreciation for a car that cost $20,000, and you expect it to last 200,000 miles. Now you can get your depreciation rate per mile. $20,000 cost to buy / 200,000 miles of useful life = 10 cents depreciation for every mile driven. That's your rate. Now apply it each year.

In year 1 you drive 20,000 miles, so the depreciation for that year would be: 10 cents x 20,000 = $2,000 depreciation. In year 2 you only drive 3,000 miles, so you only get 10 cents x 3,000 miles = $300 depreciation.
See how nice that it? A big driving year was $2,000 of depreciation, and a low mileage year was only $300. It's a pretty accurate method.

Frobvious

Sum of the Year's Digits is weird, but here's what you'd do: You add up all the years, like if an asset lasts 4 years, you do 4+3+2+1=10. Then, in the first year, you take 4/10 of the cost; in the second year, 3/10, and so on, decreasing each year.

frimbiquious

There's an important note with double declining balance. If you apply a 30% rate of depreciation to the remaining balance, it would never actually hit zero. The remaining balance just keeps getting smaller.

In practice, when it gets really tiny, you can just round down to zero and finish depreciating it.