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 straight line 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 has an accounting year end of 31 December.

Straight line depreciation method

Using the straight line depreciation method, the calculation of the annual depreciation charge
is as follows:

Dpn = (C- R)/ N

where:

Dpn = Annual straight-line depreciation charge

C = Cost of the asset

So the calculation is:

Dpn = (£75,000 - £10,000) / 5

Dpn = £13,000
in the accounts of the business a depreciation charge of £13,000 will be expensed in the profit
and loss account for each of the five years of the asset's useful economic life.

In the annual balance sheet, the machine would be shown at its original cost less the total
accumulated depreciation for the asset to date.

Example of how this would be disclosed in the accounts

At the end of the third year of ownership of the machine, the financial accounts of the
business would include the following items in relation to the machine:

In the Profit and Loss Account:

Depreciation of Machinery - Charge: £13,000

In the Balance Sheet at 31 December 2005:

  £ £
Machine at Cost 75,000
less: Accumulated Depreciation 39,000
Machine at net book value 36,000

The figure for accumulated depreciation of £39,000 at 31 December 2005 represents three
years' worth of depreciation at £13,000 per year.

The cost of the machine (£75,000) less the accumulated depreciation charged on the machine
(£39,000) is known as the "written-down value" ("WDV") or "net book value" ("NBV").

it should be noted that WDV or NBV is simply an accounting value that is the result of a
decision about which method is used to calculate depreciation. It does not necessarily mean
that the machine is actually worth more or less than the WDV or NBV.

To compare the straight line method with the "reducing balance" method, we have provided a
worked example using the same data in the following revision note.
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
      
Depreciation in 2004 (40% of WDV @ 31 December
2004 18,000
2003)
  Written down value at 31 December 2004 27,000
     
Depreciation in 2005 (40% of WDV @ 31 December
2005 10,800
2004)
  Written down value at 31 December 2005 16,200
    
Depreciation in 2006 (40% of WDV @ 31 December
2006 6,480
2005)
  Written down value at 31 December 2006 9,720
   
Depreciation in 2007 (40% of WDV @ 31 December
2007 3,888
2006)
  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.