Essay on Depreciation Methods
Congratulations on your purchase of this special-purpose machine. With every purchase of new machinery comes the depreciation value of the machine. In order to report the value of this machine, we first must figure out the total amount paid for your machine. It says here you purchased the machine for an invoice price of $1,200,000 and the freight cost was $6000 and the cost for installation was $64000. We would add all that up and get a total machine cost of $1,270,000.
There are 3 types of depreciation methods we can use to figure out the annual depreciation value of your machine: Straight Line Method, Units of Production Method, and Double Declining Method. The Straight Line Method is plain and simple. This will tell us what to report at the end of every year for the depreciation value of your machine. First, we would take the cost of the machine minus the salvage value divided by the useful life of the machine. I believe the salvage value would be the use of the machine in that year. For example, the total cost of the machine is 1270000-200000/5=214000: 200000 would be the salvage life and 5 would be the useful life of the machine, and 214000 would be our depreciation value for the year. So after the first year of use, the book value of the machine would be 1270000-214000=1056000. Every year we would subtract 214000 from the previous book value. The Units of Productions Method is a little more complicated.
This will tell us the estimated depreciation value of the machine. First, we would take the cost of the machine minus estimated salvage value divided by the predicted units of production that your machine would produce and we would get a cost per unit (depreciable). After we get the cost per unit (CPU), we would multiply it by the units produced in the period and we will get the depreciation for the period, also in the last year of the useful life of the machinery, we would depreciate to the estimated salvage value and never depreciate below the value. For example, the cost of the machine is 1270000 minus the salvage 200000 divided by the expected units that your machine would produce in its useful life which is 1000000. 1270000-200000/1000000 = $1. 07 per unit, this would be the cost per unit. Let’s say your machine will produce 200000 in its first year, so we would take the depreciation per unit to multiply the number of units produced in the period, 1. 07×200000=214000. 214000 would be the depreciation expense for the first year and we would minus that from the beginning book value of the machine.
If the machine produced 250000 the next year, we would go thru the same process again but this time we would subtract the depreciation value from the previous yearbook value and not the beginning book value. The Double Declining Method is the last method we would use to figure out the depreciation value of the machine. First, we need to figure the straight-line rate and in order to do that, we need the percent life of the machine and the useful life of the machine. We would divide each other and come up with the Straight-line rate. For example, 100% divided by 5 years equals 20% that the machine would depreciate every year if we should the straight-line rate. Second step we would double that rate, 20% x 2 = 40%. 40% would be the double-declining balance rate (ddb). In the final step, we take the double-declining balance rate multiply by the beginning period book value. For example: 40%x1270000=508000. 08000 would be the first-year depreciation expense. The book value at the end of the first year would be 1270000-580000=762000. The next year we would take 40% of 762000 and come up with the depreciation expense for that year. In its final year of useful life, the machine would never depreciate below the estimated salvage value and we would just have to adjust our books. Mr. Abella, now you know how to depreciate the value of your machine. Once again I congratulate you on your purchase.