Depreciation Methods_ Lec-1.pdf

1. Petroleum Eco-- University of Misan/Engg College/Petroleum Engg ---------Dr. Ryad Tuma
1
DEPRECIATION
Depreciation: is a measure of the wearing out, consumption or other loss of value of a depreciable asset
arising from use, passing of time or obsolescence through technology and market changes.
Short definition of Depreciation: It is Book (non cash) method to represent decrease in value of a
tangible asset over time.
Examples: of depreciable assets: are such as machines, plants, furniture’s, buildings, computers, trucks, vans,
equipment’s, etc. Moreover, depreciation is the allocation of ‘depreciable amount’, which is the
“historical cost”, or other amount substituted for historical cost less estimated salvage value. Another
point in the allocation of depreciable amount is the ‘expected useful
life’ of an asset. It has been described as “either (i) the period over which a depreciable asset is expected to
the used by the enterprise, or (ii) the number of production of similar units expected to be obtained
from the use of the asset by the enterprise.”
Depreciation terms:
 Useful life: This is the time period over which the company expects that the asset will be productive.
Depreciation is recognized over the useful life of an asset.
 Salvage value: Estimated value at end of asset’s useful life. When a company eventually disposes of an
asset, it may be able to sell it for some reduced amount, which is the salvage value. Depreciation is
calculated based on the asset cost, less any estimated salvage value. If salvage is expected to be quite
small, then it is generally or sometime ignored for the purpose of calculating depreciation.
 Book value BVt: Remaining un-depreciated capital investment of those assets in year t. this value is
recorded as in account books of company.
 Market value MV: Amount realizable if asset were sold on open market.
Factors Affecting the Amount of Depreciation:
The following factors are to be considered while charging the amount of depreciation:

2. Petroleum Eco-- University of Misan/Engg College/Petroleum Engg ---------Dr. Ryad Tuma
2
(1) The original cost of the asset.
(2) The useful life of the asset.
(3) Estimated scrap or residual value of the asset at the end of its life.
(4) Selecting an appropriate method of depreciation.
The main causes lead to Depreciation:
– Physical depreciation
– Obsolescence (functional, external or aesthetic).
– Age
– Condition
– Functional obsolescence
Methods of Depreciation
The following are the various methods applied for measuring and calculation of depreciation cost:
(1) Straight Line Method (SL)
(2) Constant Percentage Method
(3) Sum of year Digits Method (S.Y.D)
(4) Sinking Fund Method
(5) Declining Balance (DB)
(6) Double Declining Balance Method (DDB)
The following figure show the differences between three main methods (S.L D.B S.Y.D)

3. Petroleum Eco-- University of Misan/Engg College/Petroleum Engg ---------Dr. Ryad Tuma
3
1) Straight Line Method (SL):
In straight line depreciation method, cost of a fixed asset is reduced uniformly over the useful life of the asset.
Since depreciation expense charged to income statement in each period is the same, the carrying
amount of the asset on balance sheet declines in a straight line.
straight line method of depreciation is the most commonly used depreciation method. Accounting principles
require companies to depreciate its fixed assets using method that best reflects the pattern in which
the assets are being used. While the straight-line method is appropriate in many situations, some
fixed assets lose more value in initial years. In such situations other depreciation methods are more
appropriate.