Depreciation and amortisation are two important accounting concepts used to calculate the decrease in the value of assets over time.
Depreciation is used for tangible assets such as buildings and equipment, while amortisation is used for intangible assets such as patents and trademarks. In this article, we will explain how to calculate depreciation and amortisation for a financial statement.
CALCULATING DEPRECIATION
The straight-line depreciation method is the most commonly used method for calculating depreciation. This method assumes that the asset loses an equal amount of value each year over its useful life.
The formula for calculating straight-line depreciation is as follows:
Depreciation expense = (Cost of asset – Salvage value) / Useful life
NOTES:
- Cost of asset: This is the initial cost of the asset, including any additional costs associated with its acquisition, such as shipping and installation.
- Salvage value: This is the estimated value of the asset at the end of its useful life. It represents the amount that the company expects to receive when the asset is sold or scrapped.
- Useful life: This is the estimated period of time that the asset will be useful to the company before it needs to be replaced or retired.
- For example, let’s say a company purchases a machine for $100,000, with an estimated useful life of 10 years and a salvage value of $10,000. Using the straight-line depreciation method, the annual depreciation expense would be:
Depreciation expense = ($100,000 – $10,000) / 10 = $9,000 per year
CALCULATING AMORTISATION
Amortisation is used to calculate the decrease in value of intangible assets such as patents, trademarks, and copyrights. The straight-line amortisation method is similar to the straight-line depreciation method and assumes that the asset loses an equal amount of value each year over its useful life.
The formula for calculating straight-line amortisation is as follows:
Amortisation expense = (Cost of intangible asset – Residual value) / Useful life
NOTES:
- Cost of intangible asset: This is the initial cost of the asset, including any legal fees and other costs associated with its acquisition.
- Residual value: This is the estimated value of the asset at the end of its useful life. It represents the amount that the company expects to receive when the asset is sold or retired.
- Useful life: This is the estimated period of time that the asset will be useful to the company before it needs to be replaced or retired.
- For example, let’s say a company purchases a patent for $50,000, with an estimated useful life of 10 years and a residual value of $5,000. Using the straight-line amortisation method, the annual amortisation expense would be:
Amortisation expense = ($50,000 – $5,000) / 10 = $4,500 per year
REPORTING DEPRECIATION AND AMORTISATION ON FINANCIAL STATEMENTS
Depreciation and amortisation are reported on the income statement as expenses, which reduces the company’s net income. They are also reported on the balance sheet as a contra asset account, which reduces the book value of the asset over time. The accumulated depreciation and amortisation are reported on the balance sheet as a separate line item.
It’s important to note that different accounting methods and assumptions can be used to calculate depreciation and amortisation, which can result in different values for the same asset.
Companies may choose to use accelerated depreciation methods, which result in higher depreciation expense in the early years of the asset’s life, or they may use different estimates for useful life and residual value.
The method chosen by a company should be consistent over time and disclosed in the notes to the financial statements.