What is the Depreciation Rate and How to Determine it?

Depreciation Rate:

The rate or percentage at which the value of a fixed asset is depreciated using any method is called the depreciation rate. In other words, the depreciation rate is the rate that we use to charge fixed assets as depreciation expenses that report periodically in the income statement.

The result value that comes from this calculation is subtracted from the value of the asset and charged to the income statement of the entity. Or it is provided based on types and classes of fixed assets.

The rate is usually calculated on yearly basis but you can calculate for any period of time by dividing the yearly amount and adjusting to the said period.

Methods for Calculation Depreciation Expense:

The natural wear and tear that comes in the life of a non-current asset due to its use are called depreciation expense.  Every company selects the method of depreciation according to its needs.

But the large companies are mostly using the Straight-line method. As it is also preferable by GAAP. The other methods are:

The depreciation rate in the base or assumption on which value of the asset is depreciated. This assumption may differ from method to method.

Like in the straight-line method we use the estimated life as the base for calculating the depreciation expense.

Depreciation Rate under Straight Line Method:

The formula or rate in a straight line can be calculated by using the following formula:

Depreciation Expense = Total Cost of an Asset/Estimated Useful Life

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Then,

The depreciation rate formula will be = (Total Cost of an Asset/Estimated Useful Life) *100

The value that comes from this calculation can be called a depreciation rate for calculating depreciation expense under the straight-line method.

Depreciation Rate under Units of Production Method:

The depreciation rate under this method is calculated by dividing the total cost of an asset by the estimated production capacity of the asset. And then this rate is multiplied with the production of every period to get the depreciation expense.

This rate under this method will be fixed throughout the whole life asset. The formula to calculate the rate of depreciation under the units of production method is:

Rate under Units of Production Method= Total Cost of Asset-Estimated Salvage value / Estimated Capacity of production

This method is useful for seasonal companies as it provides the required fluctuation in the depreciation expense according to the production of units.

Depreciation Rate under Sum of Years Method:

The sum of year digit method is calculated on the assumption that the productivity of an asset decreases with the passage of time.

Under this method, the rate is high in the initial days of an asset which results in high depreciation expenses, and with the passage of time, the depreciation expense is decreasing as the rate also goes downwards. The formula to determine the depreciation rate is

Depreciation Expense= (Remaining Useful life of Asset/ Sum of years Digits) *Depreciable cost

For Example:

The company XYZ purchased a machine on January 1, 2019. The relevant information is given below

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Cost of the machine: $450,000

Expected useful life of machine: 5 years

Salvage value: $50,000

Required: Prepare a schedule showing the depreciation expense of each year of the useful life of the machine using sum of years’ digits method.

Solution:

Year Depreciation Base Remaining life of machine Depreciation fraction Depreciation expense Book value
1 400,000 5 5/15 133,333 266,666
2 400,000 4 4/15 106,666 159,999
3 400,000 3 3/15 80,000 79,999
4 400,000 2 2/15 53,333 26,665
5 400000 1 1/15 26,664

Double Declining Method:

This is not a common type of method used for depreciation. This is also called the 200 percent declining balance method. In this method, the rate of depreciation is higher in the early years but lower at the lower stage of asset life.

Some people resemble it as the faster shape of the straight-line method. Because if you look at the formulas of both you will understand.

Straight line depreciation rate=depreciation expense/depreciable base

Using this formula to calculate double declining depreciable rate=straight line depreciable rate*2