A Complete Guide to Depreciation of Fixed Assets

Depreciation of fixed assets is an accounting transaction that all companies have to go through, including yours.

Depreciation can be used for a wide variety of intangible assets, including:

• offices,
• IT equipment,
• software,
• tools,
• and company vehicles.

Regardless of your sector of activity, you will need tangible and intangible assets to run your business smoothly.

And… you need to recognise the value of your fixed assets and their depreciation over the years. And you can make your own by following our example of a depreciation schedule and using accounting software.

Let's delve into the meat of the issue, shall we? 👇

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What is the Depreciation of Fixed Assets?

Definition

Depreciation of fixed assets is an accounting term used to represent how much of an asset’s value has been used up over time.

Depreciation is, therefore, a calculated expense, which leads to a decrease in earnings, monthly income and unit value.

Depreciation can be related to:

• physical wear and tear, linked with time,
• or technological obsolescence.

Why is Depreciation Important in Accounting?

Depreciation is used to spread a loss in value over each accounting period.

By depreciating, you can anticipate the purchase of a new asset, when the optimal working conditions of the previous one have passed.

What is the Depreciation Rate for Fixed Assets?

The depreciation rate for fixed assets refers to the percentage of the asset's cost expensed each year over its useful life.

This rate is determined based on several factors, including:

• the type of asset,
• its expected useful life,
• and the depreciation method used.

3 Methods of Depreciating Fixed Assets

Here are some of the main types of depreciation you can use:

Straight-Line Depreciation

The straight-line method is the most basic way to record depreciation.

Straight-line depreciation determines a depreciation expense, that you will pay in equal annual instalments until the entire asset is depreciated to its salvage value.

👉 For example, if an asset is depreciated over 10 years, you will have an annual expense of 10% of the purchase value of the said asset.

🧮 Formula: (Cost - Residual Value) / Useful Life

Declining Balance Depreciation

The declining balance method is an accelerated depreciation method.

This means that assets will depreciate by the same amount each month. However, it will be expensed higher in the early years of its useful life. In contrast, the depreciation expense will be lower in the later years compared to the straight-line depreciation method.

Since the asset’s value is higher in the first few years, the declining balance method uses a higher depreciation rate during these years.

Then, it declines slightly each following year.

💡 Small businesses can use the declining balance method to deduct larger amounts at the beginning of their activity, thus paying less tax and building up more cash reserves.

🧮 Formula: Book Value at the Beginning of Year × Depreciation

Double Declining Balance Depreciation

The double-declining balance (DDB) method is an accelerated depreciation method similar to the one listed previously.

However, the uniqueness of this method is that asset value is depreciated at twice the rate it is done in the straight-line method.

🧮 Formula: Depreciation Expense=2 x (1/ Useful Life) x book Value at Beginning of Year

How to Depreciate Fixed Asset in 5 Steps

Step 1: Determine the Depreciation Period of the Asset

How to determine the depreciation period of a fixed asset?

The depreciation period of a fixed asset must correspond to the life expectancy or useful lifespan of the said asset. This has to take into consideration:

• the obsolescence of the asset,
• how frequently it is used by the company,
• the planned renewal, and so forth.

Here are a few examples of depreciation periods:

Step 2: Set the Depreciation Rate of the Asset

The depreciation period will now allow us to calculate the depreciation rate of the asset.

👉 Example for Straight-Line Depreciation Rate: A car has a depreciation period of 5 years. Its depreciation rate will be 1 / 5 = 0.20.

Step 3: Calculate the Depreciable Base

The depreciable base is the amount used to calculate annuity depreciation. It corresponds to the gross acquisition value of the asset.

This may correspond to:

• its market value (estimated value of an asset acquired free of charge),
• its purchase cost in case of acquisition,
• its cost of production in case of manufacture.

Step 4: Calculate Annual Depreciation

We will now use the depreciable base and the depreciation rate to calculate annual depreciation.

🧮 Formula for the Annual Depreciation: Depreciation Rate x Depreciable Base

👉 Example: The depreciable base for the car stated in the previous example corresponds to its purchase price, which is £12,000. Therefore, its annual depreciation will be 0.20 x 12,000 = $2,400.

Step 5: Fine-tune the calculation of depreciation annuities

If your business acquired and started to use the asset on the first day of the fiscal year, there is no need to revise the calculation of the first and last annuities.

On the other hand, if the asset was put into service during the fiscal year, this will have an impact on the depreciation annuity for the first and last years. Therefore, a pro-rata temporis adjustment should be made.

🧮 Formula of the First and Last Year's Annuity: Depreciation Rate x (Number of days used/360) x Depreciable Basis

👉 Example: The property is put into service on the 01/06/N. It will therefore only be used for 210 days out of 360 in year N, and for 150 days in year N+5.

Calculation of the first annuity: 0.20 x (210/360) x 12,000 = $1,400

Calculation of the last annuity: 0.20 x (150/360) x 12,000 = $1,000

Example of a Straight-line Depreciation Schedule

Data for the example :

• Asset Type: Computer
• Depreciation period: 4 years
• Purchase price: $3,000
• First use: 25/03
• Depreciation rate: 0.25 (or 25% )
• Pro-rata first year: 275/360
• Pro-rata last year: 85/360
• Straight-line depreciation schedule table

Calculate Depreciation With Accounting Software

If you can use an Excel table for your accounting, using an accounting software has many benefits such:

• as time-saving,
• minimising the risk of error,
• and the guarantee of complying with the laws in force.

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Depreciation of Fixed Assets, In Summary

Depreciation of fixed assets is crucial for all businesses to understand, as it represents how much of an asset's value has been used up over time.

It spreads the loss in value over each accounting period, helping companies plan for asset replacement and manage their finances effectively.

By following the outlined methods and steps, and leveraging accounting software, businesses can accurately calculate depreciation and maintain compliance with financial regulations!