Depreciation and amortization expenses are the expenses records in the income statement over the period as the result of charging on the uses of tangible and intangible non current assets. Both tangible and intangible assets are normally depreciation on monthly basis and then records those charged amount in the income statement as expenses and records in the balance sheet in the accumulated depreciation expenses which will reduce the book values of non current assets.
The concept of depreciation is that assets should not records as expenses immediately at the time they are purchasing if the useful life of assets are more than one year. Those assets should be charged as expenses base on the proportion that they are consume or use. Depreciation is apply to fixed assets only. For current assets like inventories are transferred into income statement as expenses or cost of sales that the time they are used or sold.
Based on IAS 16, the depreciation method used shall reflect the pattern in which the asset’s future economic benefits are expected to be consumed by the entity. As per IAS 16 mention three depreciation method include the straight-line method, the diminishing balance method and the units of production method. However, it also mention that there are variety methods that could be used as long as it respect the pattern of assets.
Straight line method:
Straight-line depreciation method is one of the most popular method that charge the same amount of over the useful life of assets. This method is quite easy compare to the others method.
The example of Straight-line depreciation method would be, let say company have car value 10,000, and it is the company policy to depreciation its assets based on Straight-line depreciation. For such assets, the depreciation rate assume 20%. Therefore, the depreciation per year would be USD 2,000 equally.
Diminishing balance method:
Using diminishing balance method, the depreciation amount for the first year will be high and decrease in the subsequent year. The concept is the assets are more productive in he first years and subsequently less productive. By using the same example, but the basic of depreciation is based on net book value of assets. Therefore, the depreciation expenses in the first year us the same but the second year it will be based on the next book value USD8,000(USD 10,000 – USD 2,000). The depreciation in the second year is 1,600 (8,000 * 0.2). based on this figure, you could see the depreciation in the second years is less than first year.
Units of production method:
Units of production method is the types of depreciation method that allow by IFRS. This method, the assets will be depreciated based on, for example, the unit of products that assets contribute for the period compare to total products that expected to be contributed. This method is a bit complicate as you require to estimate the production units that assets could run for in the whole useful lift. For example, the car could run for 10,000 kilometer per its useful lift, and this year it already run for 2,500 kilometer. Therefore, the depreciation for first year would be USD 2,500 [(2,500*10,000)10,000].
Declining or reducing balance method
Declining and reduce balance method is the same thing. This method, depreciation will be charged on the rate that provided to assets at the net book value after eliminating residual value. This type of depreciation method is a bit difficult compare to straight line and it is applicable to certain types of fixed assets where the valued of used or the benefit from the use are high at the first and then subsequently reduces from time to time. This kind of depreciation keep charging forever if you don’t determine the residual value and number of year to be used.
Double declining balance method
Double declining is similar to declining above, but the rate is a bit different. For declining, the rate is provided to fixed assets based on its class. However, for double declining, the rate of depreciation is based on the rate in straight line. For example, the computers will be depreciated at 25% using straight line method for four year. And if we change to use double declining, the depreciation rate will be double from 25% to 50% at the first year to its net book value.