Methods of Calculating Depreciation - SS1 Accounting Lesson Note

Depreciation is the process of allocating the cost of a fixed asset over its useful life. There are several methods of calculating depreciation and they include:

Straight-line method

This is the simplest and most commonly used method of calculating depreciation. It involves dividing the cost of the asset by its estimated useful life. The result is the amount of depreciation to be charged against the asset each year. 

For example, if an asset costs N100,000 and has an estimated useful life of 5 years, the annual depreciation charge would be N20,000 (i.e., N100,000/5).

Reducing balance method

This method calculates depreciation as a percentage of the remaining book value of the asset. The percentage used is usually higher in the early years of the asset's life and decreases over time. 

For example, if an asset costs N100,000 and has a depreciation rate of 20%, the first year's depreciation charge would be N20,000 (i.e., 20% of N100,000), and the book value of the asset at the end of the year would be N80,000. The second year's depreciation charge would then be 20% of N80,000, or N16,000.

Sum-of-the-years' digits method

This method is based on the assumption that the asset's usefulness declines more quickly in the early years of its life. Under this method, the annual depreciation charge is calculated by multiplying the asset's cost by a fraction, with the numerator being the number of years remaining in the asset's useful life and the denominator being the sum of the digits of the useful life.

For example, if an asset costs N100,000 and has a useful life of 5 years, the sum of the digits is 15 (i.e., 5+4+3+2+1). In the first year, the depreciation charge would be (5/15) x N100,000 or N33,333. In the second year, the depreciation charge would be (4/15) x N100,000, or N26,667, and so on.