Depreciation Methods Fan Company A

A Discussion on Depreciation Methods

Recommendation for Fan Company A

Depreciation Methods Fan Company A

Depreciation Methods Fan Company A

Depreciation is the process of transferring the cost of items or assets a company has from the
balance sheet to the income statement. There are several methods that fall under the umbrella of
depreciation. The most common methods are the straight-line, sum of years, declining balance,
and units of production methods. Each of these methods has its positives and negatives. As part
of my research into which method would be best for Fan Company A we will be taking a closer
look at these common methods of depreciation.
Straight Line Depreciation
Straight Line Depreciation (SLD) is a method of depreciation which involves breaking up the
adjusted cost of the equipment into equal parts for the duration of the equipments estimated
useful life. In order come up with the correct amount to depreciate the first step is to subtract the
equipments estimated salvage value from the actual cost of the equipment. This amount (CostSalvage value) becomes what is called the depreciable value or cost. The next step is to identify
the depreciable expense which involved dividing the depreciable cost against the number of
years the equipment is scheduled to last (Useful Life). The resulting value becomes the value
that is then used to depreciate the equipment every year. This value will not change until the
equipment has been depreciated completely. The best reason to use the SLD method is because it
is easy to calculate the annual depreciation amount. The issue with SLD is that since it is based
solely on time, it doesnt take into account the real rate at which the equipment is actually
depreciating in value.
Declining Balance Depreciation

Depreciation Methods Fan Company A

Declining Balance Depreciation (DBD) is a method of depreciation that aims to reduce the
depreciable expense yearly until the balance equals the Salvage value. The most commonly used
version of DBD is the Double Declining Balance Depreciation method (DDBD). In order to
calculate the yearly depreciation expense using the DDBD method the first step is to determine
what the depreciation rate (percentage) is going to be. This is done by doubling the SLD rate by
dividing the Useful Life by 100% and then multiplying the product by 2; finally dividing the
resulting value against the cost of the asset. Once the depreciation rate is calculated, the rest of
the process involves multiplying the depreciation rate by the declining book value at the start of
every year. What happens is that the value from this calculation is subtracted from the cost/book
value every year until the remaining balance equals the Salvage value. The benefit of using this
depreciation method is two-fold. More of the cost of the equipment id depreciated earlier in the
equipments life. This means that as the equipment gets older it is cheaper to depreciate and the
extra capital can be allocated to repair further in the equipments life (which is when one would
expect things to start wearing down). Also, the impact of taxable income and taxes owed for the
equipment can be reduced in the beginning of the depreciation process by using this method. The
negative aspect of using this method is that as you can see the calculations are more involved and
complicated.
Units of Production
If Fan Company A was only looking to depreciate manufacturing equipment Units of Production
(UoP) would be the best way to go. The easiest way to describe the UoP method of depreciation
would be to say that it takes into account how many units a machine can make over its lifespan
and uses that information to calculate the depreciation expense. In order to arrive at the
depreciation cost per unit, the salvage value must be subtracted from the cost and then the

Depreciation Methods Fan Company A

resulting value must then be divided by the total number of units that the machine is estimated to
be able to produce during it lifespan. This is called the Depreciation Cost per Unit (DCU). Using
the DCU the depreciation expense is calculated by multiplying the DCU against the actual
number units produced that year. This is done every year until the balance or Accumulated
Depreciation reaches the Salvage value. The positive aspect of this method is that it is relatively
easy to calculate the depreciation for each period. The negative aspect of this method is that it
doesnt consider the actual years the machine is in service (wear and tear), only how many units
it can (estimated) produce in its lifetime.
Sum of Years
The Sum of Years (SoY) method is one of the depreciation methods where the actual calculations
can get tricky. This method also creates a declining balance situation. The SoY method adds up
all the years in the Useful Life of the asset and then this number is divided by the number of
remaining years of Useful Life and multiplied against the cost of the asset. The key word to
remembering how this method works is remaining. The remaining years in the useful life
basically suggests that the depreciation calculation will be based on the total number of Useful
Life years. The next year will be one less year in the equation. This is done until the asset is
completely depleted (reaches Salvage value). The positive and negative elements to using this
method is the same as using the DDB method in that the impact of taxable income and taxes
owed for the equipment can be reduced in the beginning of the depreciation process but, the
calculations are more involved and complicated.

Depreciation Methods Fan Company A

Suggested Depreciation Method

I believe that Fan Company A would be better off using the Double Declining Balance method in
order to depreciate their assets. As stated before, if the company was only depreciating
manufacturing machinery perhaps, the UoP method would be best. Fan Company A has various
types of assets and DDB versatile enough to depreciate all of the companys assets. DDB is not
limited to how many units an asset can make. The DDB method also depreciates the assets faster
(double rate) and can provide some tax benefits early in the assets life (this would really help a
startup business). The calculations are complex but, not as complicated as the calculations used
in SoY method or as simple/narrow as SLD. In conclusion, (Double) Declining Balance
Depreciation is versatile, beneficial, and definitely the way to go!