CAT / FIA FFA Syllabus D. Recording Transactions And Events - Straight line and reducing balance methods - Notes ^{2 / 5}

Main methods

There are two main methods for calculating depreciation

Straight line method
Reducing balance method

Straight line method

The depreciation charge is the same every year.

Formula

Cost of asset – residual value
---------------------------------
Expected useful life of asset

OR

(Cost – Residual value) × %

This method is suitable for assets which are used up evenly over their useful life, e.g. fixtures and fittings in the accounts department.

Reducing balance method

This method is suitable for those assets which generate more revenue in earlier years than in later years; for example machinery in a factory where productivity falls as the machine gets older.

Under this method the depreciation charge will be higher in the earlier years and reduce over time.

Formula

Depreciation rate (%) × Net Book Value (NBV)

Net book value (NBV) / Carrying value = cost – accumulated depreciation to date

This method ignores residual value, since the NBV under this method will never reach zero.

For both methods, if depreciation is calculated on a monthly basis, and an asset has been purchased / sold in the year, then you must pro rate the depreciation charge.