How to Calculate Depreciation Expense: Definition & Formula

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  • 0:01 The Definition &…
  • 2:08 Calculating Depreciation
  • 2:36 Straight Line Depreciation
  • 3:22 Unit-of-Production…
  • 5:08 Double-Declining…
  • 7:44 Lesson Summary
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Lesson Transcript
Instructor: Tina Van Rikxoord

Tina holds a PhD in Accounting, a Master of Business in Information Security Management, and a Master of Arts in History

As property wears out, it loses some of its value, which is called depreciation. In this lesson, we will learn three of the most common methods of calculating depreciation expense, including the straight-line method.

Definition of Depreciation

Almost everything we see around us has a useful life because it is being used up little by little every day or will become outdated as technology changes. Think about the computer you are using. You probably expect it to last only about five years because every time you access it, the components inside it get used up a little bit, and improved technology will eventually make it obsolete. This 'using up' is called depreciation, and that five years is considered the computer's useful life.

The useful life of an item or asset depends upon the type of asset, or its property class, which can be determined through industry experience, personal experience, or by consulting Internal Revenue Service Publication 946, which provides a list of property classes and their useful lives.

The Process of Depreciation

As assets depreciate during their useful life, they lose some of their value. For example, the furniture you bought for $1500 five years ago, may only be worth about $500 today. People have been sitting in the chairs or on the couch, the table has scuff marks, and the fabric on the chairs isn't as bright as it was when you first bought them. No one would pay $1500 for the furniture now. It has lost some of its value.

To compensate for this loss of value caused by depreciation, businesses may write off some of the depreciation of long-lasting assets as an expense every year until the item reaches the end of its useful life. This is called residual value. It's what an item is worth at the end of its lease. For example, if you leased a car for 4 years and decided you wanted to purchase the car, the residual value would be what the car is worth now after the lease has expired and with all of the wear and tear that occurred during the lease. Long-lasting assets are things like machinery, vehicles, office furniture, and other items that are not used up quickly, excluding land. Land can never be depreciated because it does not wear out.

Calculating Depreciation

There are many ways to calculate depreciation, but the three most common methods are:

  • Straight-line method
  • Unit-of-production method
  • Double-declining balance method

To calculate depreciation, you need to know the item's useful life or total possible output, its cost (including taxes, shipping, and preparation/setup expenses), and its residual value. For the unit-of-production method, you will also need to know how many units were produced for the production run.

Straight Line Depreciation

Straight-line is the simplest depreciation method and involves allocating an even rate of depreciation every year for the life of the asset. You calculate annual straight-line depreciation as follows:

Annual Depreciation Expense = (Asset Cost - Residual Value) / Useful Life of the Asset

Example: ABC Company purchases a truck for $20,000. It has a useful life of 5 years and a residual value of $3,000.

Annual Depreciation Expense = ($20,000 - $3,000) / 5 = $3,400

Thus, ABC Company can take $3,400 in depreciation expense every year for the next five years:

Straight Line Depreciation Chart

Unit-of-Production Depreciation

Unit-of-production depreciation is a two-step process, used to calculate depreciation for assets whose useful life is measured in output capability rather than years. Calculate it as follows:

Step 1: Determine depreciation per unit like this:

Per Unit Depreciation = (Asset Cost - Residual Value) / Useful Life in Units of Production

Step 2: Figure the total depreciation of the units actually produced:

Total Depreciation Expense = Per Unit Depreciation x Units Produced

Example: XYZ Company purchases a flyer printing press for $50,000 with a useful life of 200,000 units and a residual value of $5,000. It runs a job of 5,000 flyers.

Step 1: Figure depreciation expense for each flyer produced:

Per Unit Depreciation = ($50,000 - $5,000) / 200,000 = $0.225

Step 2: Determine the total depreciation for all 5,000 flyers:

Total Depreciation Expense = $0.225 * 5,000 flyers = $1,125

Once you have figured out the per unit depreciation, you can apply it to future output runs.

Example: The same press runs two more jobs: one of 10,000 flyers and a second one of 1800 flyers.

Job One depreciation expense = $0.225 * 10,000 = $2,250

Job Two depreciation expense = $0.225 * 1800 = $405

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