# Depreciation

Depreciation...Depreciating assets impacts various financial ratios and accounting books in the following manner: 1. Depreciating assets significantly impacts the Income StatementIncome StatementThe income statement is one of the company's...

Depreciation indicates how much of fixed asset’s value has been used up. Machinery the business bought a year ago will not have the same value now. This is because the asset is used in production. Two methods of calculating depreciation:

#### Straight line method

This method assumes that a fixed asset depreciates by the same value every year.

Thus, if a piece of machinery for ABC Ltd. originally costs €28 000 and the residual value is estimated at €4 000 and expected life at 4 years, depreciation allowance would be:

So, how do we see what the value of a fixed asset will be in those 4 years? We make a table, where following the idea of the straight line method, we subtract the same depreciation allowance each year.

This is how you should present it in your exam:

 Year Depreciation Allowance (euro) Net book value (euro) 0 – 28000 1 6000 22000 2 6000 16000 3 6000 10000 4 6000 4000

• Simple.
• Quick.
• Most common, especially in Europe.

• Assumes that the depreciation is linear.
• Not realistic for something to decrease at an equal amount each year.

#### Reducing balance method

This method assumes that the depreciation charge in the early years of an asset’s life should be higher than in later years, which is more realistic. To do this, the asset must be written off by the same percentage rate each year.
 Year Depreciation Allowance (euro) Net book value (euro) 0 – 28000 1 = 28000 × 40% = 11200 16800 2 = 16800 × 40% = 6720 10080 3 = 10080 × 40% = 4032 6048 4 = 6048 × 40% = 2419 3629