In the United States, accountants have to follow generally accepted accounting principles (GAAP) to calculate and report depreciation in financial statements. GAAP has several separate allowable methods of depreciation.
Straight-Line Depreciation
This method uses the estimated salvage value (scrap value) of an asset at the end of its life and then subtracts that value from its original cost. The difference is equal to the value that is lost during the asset’s productive use. Once figured, this number is divided by the management’s best-guess estimate of the number of years that the asset will be useful.
Declining Balance Depreciation
Declining balance, a type of accelerated depreciation, is a method used to write off depreciation costs more quickly and minimize tax exposure. The most common form of declining balance is the double-declining balance, which is calculated by multiplying the straight-line rate by 2.
Usually, the declining balance method applies a higher depreciation charge to the first year of an asset’s life and then gradually decreases depreciation expenses for future years.
Sum-of-the-Years’ Digits Depreciation
The sum-of-the-years’ digits method offers as depreciation rate that accelerates more than the straight-line method but less than the declining balance method. Annual depreciation is separated into fractions using the number of years of the asset’s useful life.
For example, an asset with a useful life of five years will have a sum-of-the-years value of 15 (5+4+3+2+1). The first year is assigned a value of 5, the second year a value of 4 and so on. The depreciation rate for the first year is the straight-line value multiplied by the first year’s fraction (5/15, or one-third).
Units of Production Depreciation
Units of production assigns an equal expense rate to each unit produced, which makes it most useful for assembly or production lines. The formula involves using historical costs and estimated salvage values and then determining the expense for the accounting period, multiplied by the number of units produced.