There are two methods of calculating depreciation, the 'straight line' and the ‘reducing balance method'.
The straight line method is the easiest and most commonly used because if an asset provides the same benefit each year then the depreciation charge should be the same each year.
The reducing balance method reduces the asset by a percentage each year of the Net Book Value, thus the initial years result in a higher depreciation charge.
Straight line depreciation
Firstly state how long the asset will have a ‘useful' life, e.g. 4 years, then determine what value the asset will have when it is no longer ‘useful' ,some assets will, have a ‘scrap' value or recyclable value known as the ‘residual value'.
The amount of depreciation to charge each year is the original value less the residual value divided by the expected life of the asset. Using a laptop as an example:
Cost of Asset £1,000
Less Residual value £200
Divided by expected life of 4 years
Depreciation is £200 per year
The £200 is the amount that will be claimed as depreciation in the profit and loss accounts each year until the residual value of the asset in the balance sheet is reached.
All assets should be recorded on a ‘fixed asset register' for the business.
The Fixed Asset Register would look like this:
Year Depreciation Net Book Value
0 £nil £1000
1 £200 £800
2 £200 £600
3 £200 £400
4 £200 £200