fixed asset depreciation explained

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These are long-term or relatively permanent assets such as equipment, machinery, buildings and land that may be used by the company to generate revenue. Fixed assets exist in two forms: tangible fixed assets and intangible fixed assets.


Tangible fixed assets

These are assets that can be seen and touched physically. Examples of tangible fixed assets are: land, machinery, buildings, computers, and other company assets that can be touched.

Intangible fixed assets

These are assets that do not posses any physical form. These assets are important because of the special rights they carry. Examples of intangible fixed assets are: copyrights, patents, and trademarks are some of intangible assets a company can own.

The cost of fixed assets

In addition to purchase price, the costs of acquiring fixed assets include all amounts spent getting the asset in place and ready for use. These costs involve transport fee, any tax cost if involved, and other costs that can be directly traced to the purchase of asset.

Fixed assets Depreciation accounting

Depreciation is the process of allocating fixed asset cost over an estimated useful life of the asset. Depreciation can be calculated using one of these methods: straight-line depreciation, units-of-output method, and double-declining balance method or accelerated depreciation. We can choose one of these methods depending on the nature of the asset and other factors like which method will favor paying less income tax.

Requirement for calculating depreciation

In order to calculate depreciation of an asset, we need to know these three factors or values. The one is known and other two need to be estimated.

 Straight-line Method

This method of calculating asset depreciation is very simple and easy. The straight-line method provides for the same amount of depreciation expense for each year of the asset's useful life. The straight-line method is by far the most widely used depreciation method.

Example: let say company A purchase machinery with initial cost of 25,000 dollars. The machine is estimated to be useful for 5 years, and it estimated its residual value will be 5,000 dollars. To calculate its depreciation using straight-line method.

initial cost 25,000

expected useful life 5 years

estimated residual value 5,000

The annual straight-line depreciation of $4,000 is computed as follows:

If an asset is used for only part of year, the annual depreciation is prorated.

Units-of-output method

The unit-of-output method provides the same amount of depreciation expense for each unit of output of the asset. Depending of the nature of the asset, the units of output can be expressed in terms of hours, miles, driven or quantity produced.

Calculation of Depreciation using units-of-output method involves two:

Depreciation per unit = (cost - residual value) / total units of output.

Depreciation expense = Depreciation per unit X total units of output used.

To illustrate this, we use company A new purchased truck.

Depreciation per mile = (25,000 - 5,000) / 10,000 miles.

Depreciation per mile = $2 per mile.

Depreciation expense = $2 per mile x 3000 miles.

Depreciation expense = $6000;

The depreciation cost for the truck is $6000 for 3000 miles traveled. We are going to calculate depreciation expense like this for the remained 7000 miles.

 Double-Declining-Balance method

The double-declining-method provides for a declining periodic expense over the expected useful life of the asset. Double-declining involves three steps:

To illustrate this, we use company B purchases of machinery.

Calculate the straight-line percentage:

Calculate the double-declining rate:

Calculate the double-declining balance:

 For the first year, depreciation expense is going to be $10,000 and the book the value of asset will be $15,000 (25,000 - depreciation expense of 10,000). The second-year depreciation will be $6,000 and the book value will of the asset will be $9,000 (15,000 - depreciation expense of 6,000). This is repeated until the estimated residual value is reached.