A complete guide to depreciation of fixed assets

epreciation-of-fixed-assets

Depreciation of fixed assets is an accounting transaction that all companies have to go through, including yours.

Depreciation can be used for a wide variety of intangible assets, this includes: offices, IT equipment, software, tools, and company vehicles. Regardless of your sector of activity, you will need tangible and intangible assets to run your business smoothly. And, it is essential for you to recognize the value of your fixed assets and their depreciation over the years.

Here is a complete guide to depreciation in accounting and how you calculate it.

Then, by following our example of a depreciation schedule and using accounting software, you will be able to make your own.

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What is depreciation?

Definition

Depreciation of fixed assets is an accounting term that is used to represent how much of an asset’s value has been used up over time. Depreciation is, therefore, a calculated expense, which leads to a decrease in earnings.

Depreciation can be related to:

  • physical wear and tear, linked with time,
  • or technological obsolescence

Why is depreciation important in accounting?

Depreciation is used to spread a loss in value over each accounting period. And, by using it, you will be able to anticipate the purchase of a new asset, when the optimal working conditions of the previous one has passed.

The different types of depreciation

Here are some of the main types of depreciation you can use:

Straight-Line depreciation

The straight-line method is the most basic way to record depreciation.

Straight-line depreciation determines a depreciation expense, that you will pay in equal annual instalments until the entire asset is depreciated to its salvage value.

👉 For example, if an asset is depreciated over 10 years, you will have an annual expense of 10% of the purchase value of the said asset.

Declining balance depreciation

The declining balance method is an accelerated depreciation method. This means that assets will depreciate by the same amount however it will be expensed higher in early years of its useful life while the depreciation expense will be lower in the later years of as compared to the straight-line method of depreciation.

Since an assets’ value is higher in the first few years, the declining balance method uses a higher depreciation rate during these years. Then, it declines slightly more in each following year.

What is the advantage of using this method?

Small businesses can use the declining balance method to deduct larger amounts at the beginning of their activity, thus paying less tax and building up more cash reserves.

Double Declining Balance depreciation

The double-declining balance (DDB) method is an accelerated depreciation method similar to the one listed previously.

However, the uniqueness of this method is that asset value is depreciated at twice the rate it is done in the straight-line method.

How to calculate depreciation in 5 simple steps

Step 1: Determine the depreciation period of the asset

How to determine the depreciation period of a fixed asset?

The depreciation period of a fixed asset must correspond to the life expectancy or useful lifespan of the said asset. This has to take into consideration:

  • the obsolescence of the asset,
  • how frequently it is used by the company,
  • the planned renewal,
  • and so on...

Here are a few examples of depreciation periods:

Type of asset Depreciation period
Vehicle 4 to 5 years
Office equipment 5 to 10 years
Commercial buildings 20 to 50 years
Industrial buildings 20 years
Warehouses 20 years
Tools 5 to 10 years
Computers 3 to 5 years
Software 1 to 3 years
Furniture 10 years

Step 2: Set the depreciation rate of the asset

The depreciation period will now allow us to calculate the depreciation rate of the asset.

Calculation of the straight-line depreciation rate

Depreciation rate = (1 / useful life)

👉 Example:

A car has a depreciation period of 5 years. Its depreciation rate will be : 1 / 5 = 0.20

Step 3: Calculate the depreciable base

The depreciable base is the amount used to calculate annuity depreciation. It corresponds to the gross acquisition value of the asset.

This may correspond to:

  • its market value (estimated value of an asset acquired free of charge),
  • its purchase cost in case of acquisition,
  • its cost of production in case of manufacture.

Step 4: Calculate annual depreciation

We will now use the depreciable base and the depreciation rate to calculate annual depreciation.

Calculation of annual depreciation

Annual depreciation = Depreciation rate x Depreciable base

👉Example

The depreciable base for the car stated in the previous example corresponds to its purchase price, which is £12,000. Therefore, its annual depreciation will be: 0.20 x 12,000 = $2,400

Step 5: Fine-tune the calculation of depreciation annuities

If your business acquired and started to use the asset on the first day of the fiscal year, there is no need to revise the calculation of the first and last annuities.

On the other hand, if the asset was put into service during the fiscal year, this will have an impact on the depreciation annuity for the first and last year. And, therefore, a pro-rata temporis adjustment should be made.

Calculation of the first and last year's annuity

Depreciation rate x (number of days used/360) x Depreciable basis

👉Example

The car is put into service on the 01/06/N. It will therefore only be used for 210 days out of 360 in year N, and for 150 days in year N+5.

Calculation of the first annuity: 0.20 x (210/360) x 12,000 = $1,400

Calculation of the last annuity: 0.20 x (150/360) x 12,000 = $1,000

Example of a straight-line depreciation schedule

Data for the example :

  • Asset Type: Computer
  • Depreciation period: 4 years
  • Purchase price: $3,000
  • First use: 25/03
  • Depreciation rate: 0.25 (or 25% )
  • Pro-rata first year: 275/360
  • Pro-rata last year: 85/360
  • Straight-line depreciation schedule table
Year Calculation Depreciation Accumulated depreciation Net book value (NBV)
N 3000 x 0.25 x (275/360) 572. 92 572.92 2427.08
N+1 3000 x 0.25 750 1322.92 1677.08
N+2 3000 x 0.25 750 2072.92 927.08
N+3 3000 x 0.25 750 2822.92 177.08
N+4 3000 x 0.25 x (85/360) 177.08 3000 0

Calculate depreciation with accounting software

If you can use an Excel table for your accounting, using an accounting software has many benefits such as saving time, minimizing the risk of error and the certainty of being in compliance with the laws in force.

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