Asset Value Reduction Methods

Straight-Line Method

This approach evenly distributes the cost of an asset, less its salvage potential, over its useful life. The annual allocation is determined by dividing the depreciable base (original cost) by the estimated useful life (expressed in years). When an asset's worth at the end of its usability is considered negligible, the depreciable base is simply the initial acquisition expense.

Formula

Annual Allocation = (Asset Cost) / Useful Life

Example

A machine is acquired for $10,000 and has an estimated useful life of 5 years. With no anticipated final value, the allocation for each year is $10,000 / 5 = $2,000.

Units of Production Method

This method allocates an asset's cost based on its actual usage or output. The allocation varies directly with the level of activity. First, a rate per unit is calculated. Then, this rate is multiplied by the actual number of units produced during the period. If the ultimate obtainable value is zero, the entire acquisition expenditure is employed in the rate calculation.

Formula

Allocation Rate = (Asset Cost) / Total Estimated Production

Periodic Allocation = Allocation Rate Actual Production

Example

A machine is acquired for $50,000 and is expected to produce 100,000 units over its life. With no end value, the allocation rate is $50,000 / 100,000 = $0.50 per unit. If the machine produces 15,000 units in a year, the yearly allocation is $0.50 15,000 = $7,500.

Declining Balance Method

This is an accelerated method that results in a higher allocation in the early years of an asset's life and a lower allocation in later years. A constant rate is applied to the asset's book value (cost less accumulated allocations) each period. When assuming a worth of zero at the end of life, the full value of the asset will eventually be expensed. It's common to use double the straight-line rate, but other rates can be employed.

Formula

Periodic Allocation = Book Value Allocation Rate

Example

A truck is acquired for $20,000 and has an estimated useful life of 4 years. Using a double-declining balance method, the allocation rate is (1/4) 2 = 50%. In the first year, the allocation is $20,000 50% = $10,000. In the second year, it's ($20,000 - $10,000) 50% = $5,000, and so on.

Sum-of-the-Years' Digits Method

Another accelerated approach, this method also results in a higher allocation in the initial years. A fraction is multiplied by the depreciable base (original cost). The numerator of the fraction is the number of years of remaining useful life, and the denominator is the sum of the digits of the asset's useful life. When no worth is expected at the end of its usefulness, the original expense is the depreciable base.

Formula

Sum of the Years' Digits = n(n+1)/2, where n is the useful life

Periodic Allocation = (Remaining Useful Life / Sum of the Years' Digits) Asset Cost

Example

A computer system is purchased for $8,000 with a useful life of 4 years. With no ultimate value, the sum of the years' digits is 4(4+1)/2 = 10. In the first year, the allocation is (4/10) $8,000 = $3,200. In the second year, it's (3/10) $8,000 = $2,400, and so forth.