Depreciation Methods
Straight-line, declining balance, and units of production.
Why This Matters
You buy a delivery truck for $50,000. It'll last 5 years, then be worth about $5,000.
Question: How much expense do you record each year?
- Option 1: $50,000 in Year 1, nothing after → Misleading. Makes Year 1 look terrible.
- Option 2: Nothing until you sell it → Wrong. The truck is being "used up" every year.
- Option 3: Spread the cost across all 5 years → Correct. This is depreciation.
But here's the twist: there's more than one way to spread that cost.
Same amount every year
More in early years
Based on actual usage
What Is Depreciation?
Depreciation is the systematic allocation of an asset's cost over its useful life.
- NOT a valuation method (it's cost allocation)
- NOT cash flow (no cash moves when you depreciate)
- NOT a decline in market value (though conceptually related)
The Formula Foundation
Depreciable Base
This is the total amount that will be expensed over the asset's life.
Salvage Value: $5,000
Depreciable Base = $45,000
1Straight-Line Depreciation
The simplest and most common method. Equal expense every period.
Example: Delivery Truck
- Cost: $50,000
- Salvage: $5,000
- Life: 5 years
Annual Exp = $45,000 / 5 = $9,000
Visual Pattern
| Year | Beg. Book Value | Depreciation Exp | Accum. Depr | End Book Value |
|---|---|---|---|---|
| 1 | $50,000 | $9,000 | $9,000 | $41,000 |
| 2 | $41,000 | $9,000 | $18,000 | $32,000 |
| 3 | $32,000 | $9,000 | $27,000 | $23,000 |
| 4 | $23,000 | $9,000 | $36,000 | $14,000 |
| 5 | $14,000 | $9,000 | $45,000 | $5,000 |
Notice: Ending book value ($5,000) = Salvage value. Perfect.
2Declining Balance (Accelerated)
More depreciation in early years, less in later years. Idea: Assets provide more benefit when new.
Double-Declining Balance (DDB) uses a multiplier of 2.0
Example: Same Truck
SL Rate = 1/5 = 20%
DDB Rate = 20% × 2 = 40%
DDB ignores salvage value in the calculation! It applies the rate to Book Value.
Visual Pattern
| Year | Beg. BV | × Rate | Depreciation Exp | Accum. Depr | End BV |
|---|---|---|---|---|---|
| 1 | $50,000 | 40% | $20,000 | $20,000 | $30,000 |
| 2 | $30,000 | 40% | $12,000 | $32,000 | $18,000 |
| 3 | $18,000 | 40% | $7,200 | $39,200 | $10,800 |
| 4 | $10,800 | 40% | $4,320 | $43,520 | $6,480 |
| 5 | $6,480 | 40% | $1,480* | $45,000 | $5,000 |
*Year 5 Rule: Calculated depr. would be $2,592 (40% × $6,480), but that drops BV below salvage ($5,000). So we only depreciate down TO salvage value: $6,480 - $5,000 = $1,480. Never depreciate below salvage value!
3Units of Production
Depreciation based on actual usage, not time. Perfect for assets where wear depends on activity.
Example: Same Truck
Assume total estimated life is 150,000 miles.
Rate = ($50k - $5k) / 150k miles
Rate = $0.30 per mile
Visual Pattern
| Year | Miles Driven | × Rate | Depreciation Exp | Accum. Depr | Book Value |
|---|---|---|---|---|---|
| 1 | 40,000 | $0.30 | $12,000 | $12,000 | $38,000 |
| 2 | 35,000 | $0.30 | $10,500 | $22,500 | $27,500 |
| 3 | 30,000 | $0.30 | $9,000 | $31,500 | $18,500 |
| 4 | 25,000 | $0.30 | $7,500 | $39,000 | $11,000 |
| 5 | 20,000 | $0.30 | $6,000 | $45,000 | $5,000 |
Side-by-Side Comparison
| Year | Straight-Line | Double-Declining | Units of Prod. |
|---|---|---|---|
| 1 | $9,000 | $20,000 | $12,000 |
| 2 | $9,000 | $12,000 | $10,500 |
| 3 | $9,000 | $7,200 | $9,000 |
| 4 | $9,000 | $4,320 | $7,500 |
| 5 | $9,000 | $1,480 | $6,000 |
| TOTAL | $45,000 | $45,000 | $45,000 |
Key Insight: Total depreciation is ALWAYS the same ($45,000). Only the timing differs.
Impact on Financial Statements
INCOME STATEMENT
Revenue$100,000$100,000
Depreciation Expense(9,000)(20,000)
Other Expenses(50,000)(50,000)
Net Income$41,000$30,000
BALANCE SHEET
Equipment (Cost)$50,000$50,000
Accumulated Depreciation(9,000)(20,000)
Book Value$41,000$30,000
The accounting choice you make changes the reported profit.
Partial-Year Depreciation
What if you buy an asset mid-year? You prorate the expense.
Bought July 1 (SL Method)
Annual Depr: $6,000
Year 1: $6,000 × 6/12 = $3,000
Years 2-4: $6,000
Year 5: $6,000 × 6/12 = $3,000
Choosing a Method
- SLStraight-Line
Best for assets that provide equal benefit over time (buildings, furniture). Simplest for financial reporting.
- DDBDeclining Balance
Best for assets that lose value quickly (tech, vehicles). Popular for tax strategy to defer taxes.
- UoPUnits of Production
Best when wear depends on usage, not time (manufacturing machinery).
Key Takeaway
Depreciation allocates an asset's cost over its useful life. Straight-line spreads cost equally. Declining balance front-loads depreciation. Units of production ties it to actual usage.
All methods depreciate the same total amount (cost minus salvage); only the timing differs. The method chosen significantly affects reported profit each year, balance sheet asset values, and tax obligations.
Test Your Understanding
See if you've got the basics down. Click each option and check your answer.
Question 1: A machine costs $80,000, has a $5,000 salvage value, and a 5-year useful life. Using straight-line depreciation, what is the annual depreciation expense?
Question 2: Using double-declining balance, what is Year 1 depreciation for an asset costing $100,000 with a 10-year life?
Question 3: A truck costs $60,000 with $6,000 salvage value and is expected to travel 180,000 miles. In Year 1, it travels 45,000 miles. What is Year 1 depreciation using units of production?
Question 4: Which depreciation method results in the LOWEST net income in Year 1?
Question 5: An asset's book value can never go below:
Ready to Practice?
You now understand the three main depreciation methods. The Practice Lab lets you build complete schedules, handle partial-year calculations, and compare methods side-by-side.
Try the Practice LabWhat's Next?
Now that you understand depreciation calculations, let's look at where it goes: Accumulated Depreciation.