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Depreciation


The straight-line depreciation method allocates an equal amount of depreciation to each full accounting period in the asset¡¦s useful life.  The amount of depreciation for each period is determined by dividing the cost of the asset (or its revalued amount) minus its residual value, ie its depreciable amount, by the number of periods in the asset¡¦s useful life.

The declining balance method results in a decreasing depreciation charge over the useful life of the asset.  Depreciation expense for each period is calculated by applying a predetermined depreciation rate to the declining depreciated cost of the asset, called its carrying amount or book value.

As the straight-line method depreciates a fixed amount each year, it carries the same expense to be deducted from profit each year.  In contrary, the declining balance method results in a much higher level of depreciation in the first few years of the life of an asset, and a much lower charge in later years.  The profit of the operating year will be varied with the different depreciation amount for that year.  This method is justified only where the asset can be expected to yield more services in the earlier years than in the later years.  So the earlier years should bear a larger allocation of the cost of the asset. Hence, the differences between them are material.


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