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How to calculate accumulated depreciation

Before we begin, let us recap what depreciation is.

Depreciation is a decrease in the value of an asset over time, due in particular to wear and tear. It is written off annually using either the fixed cost method or the diminishing balance method (we’ll look into these two methods a little later).

Every year the depreciation that gets written off is accounted for as an expense and transferred to the Income Statement, just like any other expense in the business.

The accumulated depreciation, is the total of all these yearly amounts written off and is known as a negative asset, as it decreases the value of the asset.

Accumulated depreciation is the total depreciation written off on a tangible asset over time.

Now let us look at the two different methods and how we calculate accumulated depreciation in each.

Fixed cost method

Fixed cost method, also known as cost price (or straight-line) method is when a fixed amount or percentage of the cost price of the tangible asset is written off each year over the expected life of the asset.

For example, if a vehicle is purchased for R230 000 with an expected life of five years, you divide the cost by the number of years and get the annual depreciation:
R230 000 ÷ 5 = R46 000

Alternatively, a fixed percentage of 20% could be written off each year:
R230 000 x 20% = R46 000

So, each year, R46 000 will be brought into account as an expense called depreciation until the vehicle has a zero value.

 Date Annual depreciation Accumulated depreciation Year 1 230 000 x 20% = 46 000 46 000 Year 2 230 000 x 20% = 46 000 46 000 + 46 000 = 92 000 Year 3 230 000 x 20% = 46 000 92 000 + 46 000 = 138 000 Year 4 230 000 x 20% = 46 000 138 000 + 46 000 = 184 000 Year 5 230 000 x 20% = 46 000 184 000 + 46 000 = 230 000

Can you see that the same amount is written off each year?

And each year you add this amount (R46 000) to the previous year’s accumulated depreciation to calculate the current year’s accumulated depreciation?

Diminishing balance method

The diminishing balance method recognises that most tangible assets decrease more in value during their first few years than they do as time passes.

A predetermined percentage of the diminished value of the asset is written off each year as depreciation (in the example below it is 20%).

The first year works the same as the fixed cost method explained above as there is no prior depreciation with which to diminish the balance. But each year thereafter is different, it will always be a little less each year.

With the diminishing balance method, depreciation is calculated as a percentage on the book value of the tangible asset. The book value is the real value of the asset.

The real value of the asset is the cost price minus the depreciation written off to date. This value changes each year as the cumulative depreciation increases.

Let us look at our example now. If a vehicle is purchased for R230 000 and is depreciated annually at a rate of 20% on the diminishing balance method:

 Date Annual depreciation Accumulated depreciation Year 1 230 000 x 20% = 46 000 46 000 Year 2 230 000 – 46 000 = 184 000 x 20% = 36 800 46 000 + 36 800 = 82 800 Year 3 230 000 – 82 800 = 147 200 x 20% = 29 440 R82 800 + R29 440 = R112 240 Year 4 230 000 – 112 240 = 117 760 x 20% = 23 552 R112 240 + R23 552 = R135 792 Year 5 230 000 – 135 792 = 94 208 x 20% = 18 842 R135 792 + R18 842 = R154 634

Remember we said, with the diminishing balance method, depreciation is calculated as a percentage on the book value of the tangible asset and that the book value is the real value of the asset. The real value of the asset is the cost price minus the depreciation written off to date.

Let us take a closer look at how we calculate depreciation, for example, in Year 2:
R230 000 (cost price) – R46 000 (depreciation written off to date) = R184 000 (real value) x 20% (percentage) = R36 800 (depreciation for year 2).

The accumulated depreciation for Year 2 will be: R46 000 (depreciation Year 1) + R36 800 (depreciation Year 2) = R82 800

We hope these explanations and examples have helped you to understand how to calculate accumulated depreciation using the fixed cost method and the diminishing balance method.

Don’t forget to practise these calculations. Exposure to a large variety of problems will help eliminate possible fear and prevent panic during exam time!

X-kit Achieve wishes you the best of luck!