How to Calculate Depreciation on Fixed Assets In this guide we are going to learn how to calculate depreciation on Fixed Assets and Property Plant & Equipment under different methods.

Before diving deep into the topic we will be discussing the basics and make sure everything is covered.

What Is Depreciation?

Depreciation allows recognizing a portion of the cost of a fixed asset to the revenue generated by the fixed asset. This is in line with the matching principle of Accounting.

A business has to incur costs on Property, Plant and Equipment for generating revenue. These costs cannot be directly recognized as an expense when they are incurred as they help in generating revenue for more than a year.

If we do not use depreciation in accounting, then all assets have to be expensed out once they are bought. This will result in huge losses in the initial period and high profitability in periods when the revenue is booked without an offset expense.

Depreciation Calculator and Fixed Assets Manager

Depreciation vs Amortization vs Impairment

Fixed Assets can be of two types. Tangible and Intangible. Intangible assets are non-physical assets that are essential to a company, such as patents, trademarks, and copyrights, whereas Tangible assets are physical assets like Buildings, Furniture, Office equipment, Machinery etc.

Depreciation is spreading the cost of a Tangible asset over a specific period of time,

Amortization is spreading the cost of an Intangible asset over a specific period of time,

Impairment is an unusual and permanent decrease in the value of both Tangible and Intangible assets, due to physical damage, obsolescence of technology, changes in law, etc.

Are all Fixed Assets Depreciated?

All Tangible Assets which have a useful life greater than one year and whose value is expected to reduce in the coming years are eligible for depreciation.

Land is the only Tangible asset that cannot be depreciated as the value of land appreciates with time.

Tangible Assets of Nominal value can be entirely expensed out in the year in which they are purchased based on the discretion of the user.

All Intangible assets can be generally amortized over their useful life if it is greater than one year.

Inputs for Depreciation Calculation

There are four inputs required to calculate depreciation:

• Useful life – It is the period over which an asset is expected to be productive or available for use. It can also be the number of production units expected to be obtained from the asset. Depreciation is recognized over the useful life of an asset. Any change in expected useful life of an asset, should be adjusted over the remaining life of the asset, and depreciation already booked should not be retrospectively changed. Standard Useful Lives for various classes of assets are prescribed in Schedule II of the Companies Act 2013.
• Residual value – It is the reduced amount at which a company is able to dispose an asset after the completion of its useful life. Any change in expected residual value of an asset should be adjusted over the remaining life of the asset, and depreciation already booked should not be retrospectively changed. Residual value of an asset shall not be ordinarily more than five percent of the original cost of the asset as per Schedule II of the Companies Act 2013.
• Depreciable Amount – The depreciable amount of an asset is the cost of an asset less its residual value. The cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use. If the buyer is eligible to claim input tax credit of taxes then they are not included in the cost. Any trade discounts and rebates are deducted in arriving at the purchase price.
Examples of directly attributable costs are:
(i) initial delivery and handling costs,
(ii) installation cost,
(iii) professional fees, like fees of architects and engineers.
• Ready to use Date – Depreciation on assets should be charged once the asset is ready to use. Purchase date or Put to Use date is not relevant for charging depreciation. Even if an asset isn’t put to use, with the passage of time, its useful life goes on decreasing and depreciation should be charged on the same.

How to Calculate Depreciation under different Methods?

• Straight-line Method (SLM) –  The asset is depreciated equally every year over the useful life of the asset as a percentage of the Initial Cost. Depreciation is calculated for a year and proportionately adjusted if used for less than a year.

How to calculate depreciation under SLM Method

• Yearly Written Down Value (WDV) – The method distributes the asset depreciation unevenly throughout its life. It books higher expenses in the early years as assets have higher productivity and carrying value in earlier years as opposed to the later years of their life. A yearly WDV rate is calculated and annual depreciation amount is calculated from the Opening WDV of each year. Any depreciation for a part of a year is calculated proportionately from the annual depreciation amount assuming that the depreciation is incurred on straight line basis during that part. The closing WDV at the end of useful life does not match with the residual value as this method uses straight line calculation for partial year.

How to calculate depreciation under Yearly WDV Method

• Daily Written Down Value (WDV) – In this method, a daily WDV rate is calculated and depreciation amount is calculated for any period whether a year or a day by applying this rate. It is a Pure WDV method and results in slightly higher depreciation during the initial years. In this method, the closing WDV at the end of useful life exactly matches with the residual value.

How to calculate depreciation under Daily WDV Method

• Unit of Production Method (UOP) – The depreciation on an asset can be provided, where appropriate, on the basis of the units expected to be obtained from the use of the asset. The calculation is based on output capacity of the asset rather than the number of years.
Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of production

Which Depreciation Method to Choose?

It depends on the type of assets and how they are used.

The primary method for steady depreciation is the straight-line method. The advantage of using a steady depreciation rate is the ease of calculation. The straight-line depreciation method could be the most appropriate for assets such as buildings, which are used for an equal amount during each year of its useful life.

In the case of a fixed asset that is used more in the early years of its life than in the later years, the declining balance method could be useful. An example of this could be a business vehicle that is used less as it ages.

Units of production method is available if the number of units that can be produced or serviced from the use of the asset is the major limiting factor rather than the time, as with airplane engines whose life spans are tied to their usage levels.

Depreciation Journal Entry

The Accumulated Depreciation account appears on the balance sheet as a deduction from the original purchase price of an asset.

Multiple Shift Depreciation

If an asset that is eligible for extra shift charge as per Companies Act 2013, is used for a double shift, then the depreciation will increase by 50% for that period and in case of triple shift, the depreciation shall increase by 100% for that period.

Depreciation under Companies Act 2013 vs Income Tax Act 1961

ICAI Guidance Note on Depreciation Accounting in India