Lesson 41 - Intermediate Accounting Course 

41. Understanding Depreciation Methods: Straight-Line, Declining Balance, and Units of Production

Depreciation is an accounting method used to allocate the cost of a tangible asset over its useful life. Since assets lose value over time due to wear and tear or obsolescence, depreciation helps businesses match expenses to revenue generation. There are multiple methods to calculate depreciation, each with its advantages and use cases.

1️⃣ What is Depreciation?

✔ Definition: Depreciation spreads the cost of a fixed asset (e.g., machinery, vehicles, buildings) over its useful life.
✔ Why It Matters: It ensures financial statements reflect an asset’s declining value, prevents overstating profits, and allows for tax deductions.
✔ Key Factors Affecting Depreciation:

• Initial Cost: Purchase price of the asset.
  
  

• Useful Life: Estimated years the asset will be in service.
  
  

• Salvage Value: Estimated value at the end of its useful life.
  
  

• Depreciation Method: The way cost is allocated over time.

2️⃣ Common Depreciation Methods 

3️⃣ Straight-Line Depreciation

✔ Definition: Spreads the asset’s cost evenly over its useful life.
✔ Formula:

Example:

• Equipment Cost = $10,000
  
  

• Useful Life = 5 years
  
  

• Salvage Value = $1,000

✔ The business records $1,800 in depreciation expense annually for 5 years.

📌 Pros:
✔ Easy to calculate.
✔ Provides consistent expense allocation.
❌ Cons:
✖ Doesn’t reflect accelerated wear and tear of some assets.

4️⃣ Declining Balance Depreciation (Accelerated Method)

✔ Definition: Depreciates more in the early years, assuming assets lose value faster initially.
✔ Formula:

• Double-Declining Balance (DDB) Method: Uses twice the straight-line rate for faster depreciation.
  
  

Example (DDB):

• Equipment Cost = $10,000
  
  

• Useful Life = 5 years
  
  

• Depreciation Rate = 40% (Double of 1/5 or 20%)

✔ In Year 1, depreciation is higher, reducing taxable income more quickly.

📌 Pros:
✔ More realistic for assets that lose value faster (e.g., computers, cars).
✔ Tax benefits in early years.
❌ Cons:
✖ More complex calculations.
✖ Not ideal for long-term assets like buildings.

5️⃣ Units of Production Depreciation

✔ Definition: Bases depreciation on actual asset usage instead of time.
✔ Formula:

Example:

• Equipment Cost = $10,000
  
  

• Expected Output = 50,000 units
  
  

• Salvage Value = $1,000
  
  

• Depreciation Per Unit:

If 10,000 units are produced in Year 1: 

✔ Depreciation varies each year depending on usage.

📌 Pros:
✔ Ideal for manufacturing assets.
✔ Matches expenses with revenue generation.
❌ Cons:
✖ Requires precise tracking of asset usage.
✖ Not practical for all assets.

6️⃣ Comparing the Methods 

7️⃣ Choosing the Right Method

✔ Straight-Line: Use for assets with consistent usefulness (e.g., buildings, office furniture).
✔ Declining Balance: Ideal for assets that depreciate quickly (e.g., electronics, cars).
✔ Units of Production: Best for machinery and assets where wear depends on usage.

8️⃣ Final Thoughts

✔ Depreciation is essential for tracking asset value and managing expenses.
✔ The best method depends on the asset type, financial strategy, and tax considerations.
✔ Businesses often use a combination of methods for different asset classes.

Understanding depreciation helps in accurate financial reporting, tax planning, and better decision-making regarding asset investments.