Depreciation Estimation Method
Depreciation is classified as a significant type of internal capital. Only fixed asset is taken to calculate depreciation since depreciation is the deduction of fixed asset usage value in each year since high amount of capital must be paid to purchase fixed asset. However, it can be used for several years. When it is used, it will be deteriorated according to useful life such building, plant, machinery and vehicle, etc., except land of which its depreciation is not estimated since land is not deteriorated and land price tends to be higher all the time. Therefore, depreciation of usage shall be deducted for accumulation in purchase of new piece of fixed asset. This accumulated depreciation can be used as working capital in the business when it has not been taken for use in purchase of new fixed assets.
Meaning of Vocabularies that should be known
Scrap value or Salvage value means value expected to purchase that fixe asset when useful life is expired by deduction with removal cost and disposal expense of that asset (if any).
Total depreciation value means former cost price of deteriorated asset or other price used for representation appeared in financial statement that is deducted with estimated scrap value.
Total Deprecation Value = Cost Price of Asset – Scrap Value
Useful life means duration of which the business expected to utilize from that fixed asset.
Depreciation of fixed assets is estimated applying several methods. Depreciation derived in each method that causes additional accumulation of internal capital is different amount. When business selects any method of depreciation calculation, it is necessary to frequently apply that method in every accounting period. The method of depreciation calculation will be changed upon approval from the Director-General of Revenue Department. For example, a construction contractor purchases new machine with 25,800 Baht value under expectation on 5-year useful life and 800 Baht of scrap value in the end of the 5th year. The business therefore distributes useful life values of the machineries by estimating depreciation in each year. The method of depreciation estimation can be done by several methods as follows.
- 1.) Straight-Line Method : is the method of deprecation estimation by equally averaging asset deprecation as depreciation in each year throughout useful life of that fixed asset. The formula of deprecation calculation is as follows.
Annual Depreciation = (Cost Price of Asset –Scrap Value) / Useful Life
- Value Machinery 25,800 Baht
- Value Scrap 800 Baht
- Value of machinery after value deductionScrap 25,000 Baht
- Useful Life 5 years
Therefore, annual depreciation is 25,000 / 5 = 5,000 Baht.
- 2.) Double-Declining Balance (DDB) Method : is a method of
depreciation estimation by estimating in the initial years to be higher than latter years. This method is the method of depreciation estimation in type of acceleration rate by the way that it is double estimation of Straight - Line Method and depreciation in each year will take double amount of Straight-Line Method to multiply with machinery value that is deducted with depreciation in each year. Therefore, from previous example,
Straight - Line Method : depreciation is annually deducted for 1/5 (6,800/34,000) of machinery value after deduction of scrap value.
Double – Declining Balance (DDB) Method : depreciation is annually deducted ( 1/5 ) x 2 = 2/5 times of machinery after deduction of scrap value and deduction of depreciation for each year as follows.
- Year 1 depreciation is 2/5 ( 25,000 ) = 2,000 Baht.
- Year 2 depreciation is 2/5 ( 23,000 ) = 9,200 Baht.
- Year 3 depreciation is 2/5 ( 13,800 ) = 5,520 Baht.
In addition, since Year 3, depreciation is below the estimation in type of Straight – Line, machinery balance in Year 4 and 5 are divided by 2 and then annual depreciation is 3,312/2 = 1,656 Baht.
- 3.) Units – of – Production Method : is the method for estimation of actual depreciation. Ifmachine produces 1,000, deprecation is 1,000 Baht. If the following year produces 2,000, it indicates that machinery is used more. More depreciation must be estimated. It is the method of depreciation estimation based on number of produced units (unit of goods produced using that machinery) in each installment. Therefore, this machine shall be calculated throughout its life on how many units that total output can be produced and how much depreciation of the machinery is caused from each unit of output. Then, it can be found that each installment of production will generate how much depreciation of this machinery.
From previous example, it is assumed that this machine produces total products for 5,000 units, therefore.
Depreciation per Output Unit = ( 25,800 - 800 ) / 5,000
= 5 Baht
If the first year, product is produced for 1,000 units, it indicates that depreciation of machinery in the first year = 5 x 1,000 = 5,000 and depreciation in the following year is also calculated.
- 4.) Sum of Years’ Digits Method : is the method of depreciation estimation in type of acceleration rate by the way that depreciation in the initial years will be high and gradually reduced in the latter years. This rate is taken for calculation of deprecation which is the proportion of number of years of the remaining machinery’s useful life per number of years of the remaining useful life in combination as follows.
Year 1 the remaining useful life of machinery is 5 years
Year 2 the remaining useful life of machinery is 4 years
Year 3 the remaining useful life of machinery is 3 years
Year 4 the remaining useful life of machinery is 2 years
Year 5 the remaining useful life of machinery is 1 years
Therefore, total number of years of remaining useful life is 5+4+3+2+1 = 15, therefore,
Year 1 Deprecation = 5/15 (25,000) = 8,333 Baht
Year 2 Depreciation = 4/15 (25,000) = 6,667 Baht
Year 3 Depreciation = 3/15 (25,000) = 5,000 Baht
Year 4 Depreciation = 2/15 (25,000) = 3,333 Baht
Year 5 Deprecation = 1/15 (25,000) = 1,667 Baht
- From all 4 methods of deprecation estimation4 aforesaid, it is unnecessary for each company to estimate depreciation by the same method. However, it depends on the concept of that company in which concept is applied and the executive will know that internal capital is derived from how much depreciation.