Accountancy · Ch 7 — Depreciation, Provisions and Reserves
Basis of Charging Depreciation
Basis of Charging Depreciation
The Basis of Charging Depreciation
The core idea is simple: depreciation is an expense that must be allocated each year. But on what amount do you calculate that year's depreciation? The answer depends on which method you choose.
There are two main methods, and they differ fundamentally in their basis:
Straight Line Method (SLM)
Under the Straight Line Method, depreciation is calculated on the original cost of the asset. This original cost is also called the historical cost — the price paid to acquire the asset, including all expenses needed to bring it to its usable condition.
The logic is that the asset provides equal service every year, so it should lose an equal amount of its original value each year. The depreciation charge remains constant throughout the asset's life.
Annual Depreciation (SLM) = (Original Cost – Estimated Scrap Value) / Estimated Useful Life
Written Down Value Method (WDV)
Under the Written Down Value Method, depreciation is calculated on the net book value of the asset at the beginning of the year.
Net book value is defined as: Original cost less depreciation accumulated up to that date.
The logic here is different. An asset loses more value in its early years (when it is new and efficient) and less in later years (when it is older and requires more repairs). The depreciation charge is highest in the first year and decreases each subsequent year.
Depreciation for the year (WDV) = Book Value at the beginning of the year × Fixed Rate of Depreciation
Key Distinction at a Glance
| Feature | Straight Line Method (SLM) | Written Down Value Method (WDV) |
|---|---|---|
| Basis of charge | Original cost (historical cost) | Net book value at the start of the year |
| Annual depreciation amount | Constant (equal every year) | Declining (decreases each year) |
| Book value at end of life | Reaches scrap value | Never reaches zero (approaches scrap value) |
Accounting Treatment — The Journal Entry
Regardless of which method is used, the accounting entry to record depreciation is the same. The logic is:
- Depreciation is an expense (a loss of value). Therefore, Depreciation Account is debited. …