Question

• How do the three methods of depreciation (include straight line method, units of production and double declining balance method.) affect the income statement and the balance sheet?

Answer 1

The Straight Line Method

In this method of depreciation, we write off a fixed value every year during the useful life of the asset. The reason for this being reduction of the value of the asset to zero or the scrap value at the end of the useful life. In this method, we spread the cost of the asset equally over the lifetime of the asset. This method is also known as fixed instalment method.

A particular asset is expected to generate equal utility during its useful life. Let’s understand the formula for calculating the rate of depreciation by the straight line method:

Depreciation rate = Depreciation / cost of asset * 100

The Written Down Value Method

In this method, a fixed percentage of the reducing balance is written off every year as depreciation. This reduces the fixed asset to its residual value at the end of its working life. This method is also known as reducing balance or diminishing balance method where the annual charge of depreciation keeps on decreasing every year.

The depreciation charged in the initial years is higher as compared to the subsequent years. According to this method, the value of the asset is not fully extinguished. Let’s understand the formula for calculating the rate of depreciation:

Image result for wdv formulaThe double declining balance method of depreciation, also known as the 200% declining balance method of depreciation, is a form of accelerated depreciation. This means that compared to the straight-line method, the depreciation expense will be faster in the early years of the asset's life but slower in the later years. However, the total amount of depreciation expense during the life of the assets will be the same.

The "double" means 200% of the straight line rate of depreciation, while the "declining balance" refers to the asset's book value or carrying value at the beginning of the accounting period. Since book value is an asset's cost minus its accumulated depreciation, the asset's book value will be decreasing when the contra asset account Accumulated Depreciation is credited with the depreciation expense of the accounting period.