How to Calculate Depreciation
There are two main methods used in the UK to calculate depreciation – the straight line method and reducing balance method. Here are the steps you need to take to depreciate your fixed assets.
Step 1: Estimate Useful Life of Your Asset
To calculate depreciation you first need to make an estimate of the useful life of the asset. Useful life in accounting refers to the number of years the asset in question will remain in service to the business and contribute to income generation. For example: if you buy a new laptop you may estimate that you will use the laptop for 3 years before it becomes obsolete and need replacing. Therefore the useful life of your computer equipment is 3 years.
Step 2: Choose Depreciation Method
Once you have worked out useful life, then in accounting your fixed asset can be written off over useful life in two different ways:
Straight Line Method of Depreciation
The straight line method is the simplest way to depreciate fixed assets where you write off the asset over the useful life in equal amounts. The calculation is:
Depreciation = Cost of Fixed Asset / Useful Life of Fixed Asset
You have purchased a laptop for £1,000 with a useful life of 3 years. Therefore the laptop will be depreciated at £333.33 per year for 3 years (£1,000/3 years).
Reducing Balance Method of Depreciation
The reducing balance method of depreciation is used if an asset depreciates more at the start of its life compared to the end of its life. It is particularly applicable if you have an asset that loses significant value at the beginning of its life, such as a van or lorry.
In the first year you depreciate the asset by a percentage and then in the following years depreciate the asset at the same percentage but based on the remaining value rather than the original cost.
You have purchased a company pickup truck for £44,000 and estimate it will lose 30% of its value in the first year. Depreciation for the first 5 years would be worked out as follows:
|Year||Value||Depreciation (30%)||Book Value remaining|