balance sheet - straight line depreciation: worked example
Introduction
In our introduction to the methods available to calculate depreciation, we suggested that there are two main methods that can be used:
- Straight- line depreciation
- Reducing balance method
We emphasised the point that these two methods simply provide an alternative way of allocating the total depreciation charge over several accounting periods. The total depreciation charge using either method will be the same over the total useful economic life of the asset.
To illustrate the reducing balance depreciation method, we have calculated the depreciation charge for the following asset:
Data
A business purchases a new machine for £75,000 on 1 January 2003. It is estimated that the machine will have a residual value of £10,000 and a useful economic life of five years. The business decides to calculate annual depreciation at the rate of 40% of the written-down value. The business has an accounting year end of 31 December.
Reducing balance depreciation method
Using the straight line depreciation method, the calculation of the annual depreciation charge is as follows:
| 31 December | £ |
|
| Original machine cost | 75,000 |
|
| 2003 | Depreciation in 2003 (40% cost) | 30,000 |
| Written down value at 31 December 2003 | 45,000 |
|
| 2004 | Depreciation in 2004 (40% of WDV @ 31 December 2003) | 18,000 |
| Written down value at 31 December 2004 | 27,000 |
|
| 2005 | Depreciation in 2005 (40% of WDV @ 31 December 2004) | 10,800 |
| Written down value at 31 December 2005 | 16,200 |
|
| 2006 | Depreciation in 2006 (40% of WDV @ 31 December 2005) | 6,480 |
| Written down value at 31 December 2006 | 9,720 |
|
| 2007 | Depreciation in 2007 (40% of WDV @ 31 December 2006) | 3,888 |
| Written down value at 31 December 2007 | 5,832 |
The reducing balance method can result in significant differences in the annual depreciation charge, depending on the "percentage" of written-down value that is used to calculate the charge.
In the example above, the total amount charged to depreciation in the first three years of owning the machine (2003-2005) was £58,800 (compared with £39,000 if a straight line depreciation method has been used).
To compare the reducing balance method with the "straight line" method, we have provided a worked example using the same data in the following revision note.
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