How is the depreciation charge calculated?

A

The depreciation charge is calculated on the estimated useful economic life of the assets at the time of acquisition. If there is a change in the estimated economic life during a period when the asset is under use by the businesses, then there is a need to amend the depreciation amount charged against the income. This can be explained by giving a small example of a physical asset that is purchased by a business for $500,000, and it is expected to have a useful life of 25 years, and it has no residual value. For the first year and subsequent years, the depreciation charge is calculated using the straight-line method as $500,000/25=$20,000 per annum. This amount is charged against the income from the business every year. However, if after five years of the asset using, the expected life of that asset is revised to only ten years. Then the depreciation expense needs to be revised accordingly to spread out the economic value of the asset over the remaining period of time. Since for the first five years depreciation has been charged at a rate of $20,000 per year, this implies that by the end of the 5th year, there is an accumulated depreciation of $250,000 recorded in the balance sheet. The netbook value of the asset at the beginning of the 6th year is $250,000, which will be required to spread over the remaining useful life of 5 years. This implies that a depreciation charge of 250,000/5=$50,000 per annum will be made against the income for the next years in order to achieve a salvage value of nil. However, the change in the estimated life of an asset is considered to be a change in estimate that can affect the present status and expected future benefits, and this must be disclosed by the businesses in their annual report.

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