Depreciation expense
Depreciation expense refers to the allocation of the cost of a tangible asset over its useful life. When a company acquires a long-term asset, such as equipment, buildings, or vehicles, it doesn't expense the entire cost of the asset in the year of purchase.
Instead, it spreads the cost over the asset's useful life through depreciation. Depreciation is an accounting concept that recognizes the wear and tear, obsolescence, or decline in value of an asset over time. It is recorded as an expense on the income statement, which reduces the company's net income and ultimately its taxable income.
The calculation of depreciation expense depends on several factors, including the cost of the asset, its estimated useful life, and its estimated residual value (the expected value at the end of its useful life).
There are different methods of depreciation, including straight-line depreciation, declining balance depreciation, and units-of-production depreciation.
Straight-line depreciation method:
Straight-line depreciation is the most common method, where the cost of the asset minus its residual value is divided equally over its useful life.
For example, if a company purchases a piece of equipment for $10,000 with a useful life of 5 years and no residual value, the annual depreciation expense would be $2,000 ($10,000 / 5).
Declining balance depreciation method:
Declining balance depreciation methods, such as double-declining balance (DDB), result in higher depreciation expenses in the earlier years of an asset's life and lower expenses in the later years. This method recognizes that assets often lose value more rapidly in the early years.
Units-of-production depreciation method:
Units-of-production depreciation considers the actual usage or production of the asset. The depreciation expense is based on the number of units produced or the hours the asset is used.
This method is commonly used for assets like vehicles or manufacturing equipment. It's important to note that depreciation is a non-cash expense.
Although it reduces net income, it does not involve an outflow of cash. Instead, it reflects the allocation of the asset's cost over time to match the revenue it generates or the benefits it provides. Depreciation expense is a crucial element in financial statements as it impacts the calculation of net income, which affects profitability ratios, taxes, and overall financial performance.
Wimax Company limited
Calculation of depreciation Expense
Year-2021
Opening cost (as on 1 July-2021) xxxx
Add: Addition (Purchase) xxxx
(Less): Adjustment on loss on fire (xxxx)
Total cost as on 30 June-2022 xxxx
(Less) Accu -depreciation (July-01-2021) (xxxx)
Depreciable value as on (July-01, 2021) xxxx
So, Depreciation Expense during the Year (2022)
“Depreciable value *Depreciation rate” = xxxx