How To Understand Calculating Depreciation
At the end of the useful life of an asset value there may or may not be a
Hi, my name is Grant Hobson. I have been a finance analyst for the past six years. Today, I am going to run you through some financial performance methods as well as some investment appraisal techniques. How to calculate depreciation? In the accounting business, we try to recognize the fact that the value of a non-accruing asset will be consumed as the asset wears out. So rather than expense the full value of the asset upon purchase, we expense it over the time we will be using it for. It is deemed more accurate this way. We are reflecting the cost of the asset against the revenue it generates. The method is to gradually write off the cost, the profit and loss over several accounts and periods. These accounts and periods will consist of the useful life of the asset. In terms of the calculation, there are two methods that can be used. We have the straight line method and the reduce in balance method. In terms of the straight line method, let's say we have an asset value of 55,000 pounds. Now at the end of the useful life of an asset, there may or may not be a residual value. The residual value, in this example is 5,000 pounds. It's what we deem we can sell the asset for what it is worth at the end of its useful life. In most cases, the residual values are negligible or even zero. The useful life in this example is 4 years. Each year you should revisit the useful life of the asset in your accounts and check the depreciation figure you're expensing is accurate. The calculation is a quite simple one. Through over the 4 years, the straight line method is, 55,000 pounds of the asset value, minus your residual value, gives you 50,000 pounds. We then have a useful life of four years. So each year, we show the depreciation expensed evenly in the accounts. We have 50,000 pounds divided by 4 years means we show a depreciation value of 12,500 pounds each year.