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Depreciation Methods Explained: Straight Line, Written Down Value and Units of Production
When a business purchases machinery, vehicles or equipment, the cost is generally not treated as an expense entirely in the year of purchase. Instead, the depreciable amount is allocated over the asset’s useful life.
This process is called depreciation.
Understanding depreciation methods in accounting is important for CA, CMA and commerce students because different methods affect the depreciation expense reported each year, the carrying amount of assets and the company’s accounting profit.
The three commonly studied methods are the Straight Line Method (SLM), Written Down Value Method (WDV) and Units of Production Method.
Each method follows a different approach to allocating the cost of an asset. The appropriate method depends on how the asset’s economic benefits are expected to be consumed.
What Is Depreciation in Accounting?
Depreciation is the systematic allocation of the depreciable amount of a tangible asset over its useful life.
Businesses use assets such as machinery, computers, vehicles and office equipment to generate income over several accounting periods.
Rather than charging the entire cost of such an asset to one period, depreciation spreads its depreciable amount across the periods that benefit from its use.
For example, suppose a company purchases machinery for ₹5,00,000 and expects to use it for five years.
If the estimated residual value is ₹50,000, the depreciable amount is:
Depreciable Amount = Cost of Asset − Residual Value
₹5,00,000 − ₹50,000 = ₹4,50,000
The company allocates this ₹4,50,000 over the machinery’s useful life using an appropriate depreciation method.
Depreciation is an accounting expense. It does not represent a cash payment made each year.
The cash outflow generally occurs when the asset is purchased or paid for.
Why Do Businesses Charge Depreciation?
Depreciation helps businesses recognise the cost of using long-term assets during the periods in which they provide economic benefits.
It serves several important purposes:
- Allocates an asset’s depreciable amount over its useful life.
- Helps determine accounting profit for each period.
- Reduces the carrying amount of depreciable assets over time.
- Supports financial reporting and asset management.
- Helps businesses analyse the cost of using machinery and equipment.
Depreciation does not directly measure the current market value of an asset.
A machine may have a carrying amount of ₹2 lakh in the books but a different resale value in the market.
This distinction is important when interpreting financial statements.
Types of Depreciation Methods in Accounting
Three important depreciation methods are:
- Straight Line Method (SLM).
- Written Down Value Method (WDV), also called the Diminishing Balance Method.
- Units of Production Method.
Although all three allocate depreciation over an asset’s useful life, they calculate the annual expense differently.
1. Straight Line Method of Depreciation
The Straight Line Method charges an equal amount of depreciation during each full accounting period over an asset’s useful life, assuming the estimates remain unchanged.
It is one of the simplest and most commonly taught depreciation methods.
Straight Line Method Formula
Annual Depreciation = (Cost of Asset − Residual Value) ÷ Useful Life
Practical Example of Straight Line Depreciation
ABC Manufacturing Ltd. purchases a machine with the following details:
| Particulars | Amount |
|---|---|
| Cost of machinery | ₹5,00,000 |
| Estimated residual value | ₹50,000 |
| Estimated useful life | 5 years |
| Depreciable amount | ₹4,50,000 |
Annual depreciation is:
(₹5,00,000 − ₹50,000) ÷ 5
= ₹90,000 per year
The company records ₹90,000 as depreciation expense for each full year.
Straight Line Depreciation Schedule
| Year | Opening Carrying Amount | Depreciation | Closing Carrying Amount |
|---|---|---|---|
| 1 | ₹5,00,000 | ₹90,000 | ₹4,10,000 |
| 2 | ₹4,10,000 | ₹90,000 | ₹3,20,000 |
| 3 | ₹3,20,000 | ₹90,000 | ₹2,30,000 |
| 4 | ₹2,30,000 | ₹90,000 | ₹1,40,000 |
| 5 | ₹1,40,000 | ₹90,000 | ₹50,000 |
At the end of five years, the machinery has a carrying amount of ₹50,000, equal to its estimated residual value.
Advantages of the Straight Line Method
- Easy to calculate and understand.
- Provides a consistent annual depreciation expense.
- Useful when an asset’s economic benefits are consumed relatively evenly.
- Makes depreciation budgeting straightforward.
Limitations of the Straight Line Method
The method may not reflect actual asset usage when machinery is used heavily in the early years and less frequently later.
It also does not automatically account for changes in production activity.
For example, a machine producing 50,000 units in one year and 20,000 units in another may still attract the same annual depreciation under SLM.
2. Written Down Value Method of Depreciation
The Written Down Value Method calculates depreciation using a fixed percentage of the asset’s opening carrying amount each year.
It is also known as the Reducing Balance or Diminishing Balance Method.
Under this method, depreciation is generally higher in the earlier years and decreases over time.
This approach may be appropriate when an asset’s economic benefits are expected to be consumed more heavily during its initial years.
Written Down Value Method Formula
Annual Depreciation = Opening Carrying Amount × Depreciation Rate
Unlike the Straight Line Method, depreciation is calculated on the reducing carrying amount rather than the original cost each year.
Practical Example of WDV Depreciation
Suppose ABC Manufacturing Ltd. purchases machinery for ₹5,00,000.
Assume a depreciation rate of 20% per year for illustration.
First-year depreciation:
₹5,00,000 × 20% = ₹1,00,000
Closing carrying amount:
₹5,00,000 − ₹1,00,000 = ₹4,00,000
Second-year depreciation:
₹4,00,000 × 20% = ₹80,000
The depreciation expense decreases because the carrying amount reduces each year.
Written Down Value Depreciation Schedule
| Year | Opening Carrying Amount | Depreciation at 20% | Closing Carrying Amount |
|---|---|---|---|
| 1 | ₹5,00,000 | ₹1,00,000 | ₹4,00,000 |
| 2 | ₹4,00,000 | ₹80,000 | ₹3,20,000 |
| 3 | ₹3,20,000 | ₹64,000 | ₹2,56,000 |
| 4 | ₹2,56,000 | ₹51,200 | ₹2,04,800 |
| 5 | ₹2,04,800 | ₹40,960 | ₹1,63,840 |
After five years, the machinery has a carrying amount of ₹1,63,840 under the assumed 20% rate.
Important: This example uses an illustrative rate to demonstrate the calculation. It does not use a rate derived from a five-year useful life and ₹50,000 residual value.
If the asset is expected to reach a particular residual value at the end of its useful life, the depreciation rate must be selected consistently with that estimate.
For the same ₹5,00,000 asset, five-year useful life and ₹50,000 residual value, the approximate reducing-balance rate would be 36.90% per year, assuming no changes in estimates.
Advantages of the Written Down Value Method
- Recognises higher depreciation during the early years.
- May better reflect assets whose benefits decline over time.
- Reduces the annual depreciation expense as the carrying amount falls.
- Can be useful for certain machinery, vehicles and equipment.
Limitations of the Written Down Value Method
The calculation is more involved than the Straight Line Method.
A fixed reducing-balance rate may also fail to reflect actual asset usage.
Furthermore, applying a fixed percentage repeatedly does not automatically reduce an asset to its estimated residual value within a specified useful life unless the rate and final-year treatment are appropriately determined.
3. Units of Production Method of Depreciation
The Units of Production Method calculates depreciation based on actual production or usage rather than the passage of time.
It is particularly useful when an asset’s economic benefits are consumed in proportion to its output.
For example, a manufacturing machine may produce different quantities in different years.
Under this method, depreciation increases when production is higher and decreases when production is lower.
Units of Production Method Formula
Depreciation per Unit = (Cost − Residual Value) ÷ Estimated Total Production
Depreciation Expense = Depreciation per Unit × Actual Units Produced
Practical Example of Units of Production Depreciation
ABC Manufacturing Ltd. purchases machinery with the following details:
| Particulars | Amount |
|---|---|
| Cost of machinery | ₹5,00,000 |
| Residual value | ₹50,000 |
| Depreciable amount | ₹4,50,000 |
| Estimated total production | 1,00,000 units |
Depreciation per unit:
₹4,50,000 ÷ 1,00,000 = ₹4.50 per unit
Suppose the machine produces 25,000 units during the first year.
First-year depreciation:
25,000 × ₹4.50 = ₹1,12,500
If production falls to 15,000 units in the second year:
15,000 × ₹4.50 = ₹67,500
The depreciation expense changes according to actual production.
Units of Production Depreciation Schedule
| Year | Units Produced | Depreciation Expense |
|---|---|---|
| 1 | 25,000 | ₹1,12,500 |
| 2 | 15,000 | ₹67,500 |
| 3 | 20,000 | ₹90,000 |
| 4 | 25,000 | ₹1,12,500 |
| 5 | 15,000 | ₹67,500 |
| Total | 1,00,000 | ₹4,50,000 |
The total depreciation equals the depreciable amount of ₹4,50,000.
The asset’s closing carrying amount is ₹50,000, assuming the estimated output is achieved and no other accounting adjustments are required.
Advantages of the Units of Production Method
- Reflects actual production or usage.
- Useful for machinery whose wear and consumption of benefits depend mainly on output.
- Allocates higher depreciation to periods of greater production.
- Helps connect asset costs with production activity.
Limitations of the Units of Production Method
The method requires reliable production or usage records.
It also depends on estimating the asset’s total expected output.
If production estimates change significantly, depreciation calculations may need to be revised.
This method may be less suitable when the asset’s economic benefits decline mainly because of time, ageing or technological obsolescence rather than production.
Straight Line vs WDV vs Units of Production: Key Differences
The following table compares the three depreciation methods.
| Basis | Straight Line Method | Written Down Value Method | Units of Production Method |
|---|---|---|---|
| Calculation basis | Depreciable amount and useful life | Opening carrying amount and rate | Actual production or usage |
| Annual depreciation | Generally equal | Generally decreases | Varies with output |
| Main factor | Passage of time | Reducing carrying amount | Asset usage |
| Calculation | Simple | Moderately complex | Requires output records |
| Early-year expense | Constant | Usually higher | Depends on production |
| Suitable assets | Assets with relatively uniform benefit consumption | Assets with declining benefit consumption | Production-dependent machinery |
| Residual value | Directly included in formula | Considered when determining appropriate rate and limits | Directly included in formula |
The appropriate depreciation method should reflect the expected pattern in which the asset’s future economic benefits are consumed.
It should not be selected merely because it produces a preferred profit figure.
How Different Depreciation Methods Affect Business Profit
Depreciation is an expense in the profit and loss account.
Therefore, a higher depreciation expense generally reduces accounting profit, while a lower expense generally results in higher profit, assuming all other factors remain unchanged.
Consider a company with profit before depreciation and tax of ₹3,00,000.
Assume the following first-year depreciation amounts:
| Particulars | SLM | WDV | Units of Production |
|---|---|---|---|
| Profit before depreciation | ₹3,00,000 | ₹3,00,000 | ₹3,00,000 |
| Depreciation | ₹90,000 | ₹1,00,000 | ₹1,12,500 |
| Profit after depreciation, before tax | ₹2,10,000 | ₹2,00,000 | ₹1,87,500 |
The company reports different accounting profits depending on the depreciation method used.
The asset’s original purchase cost has not changed.
Only the allocation of its depreciable amount across accounting periods differs.
The depreciation figures follow the illustrative calculations above. The WDV example uses an independently assumed 20% rate, while the other methods use the stated five-year life and residual value. This table demonstrates the effect on first-year profit rather than a fully like-for-like depreciation policy comparison.
Journal Entry for Depreciation
Depreciation is generally recognised as an expense with a corresponding increase in accumulated depreciation.
Suppose a company records annual depreciation of ₹90,000 on machinery.
The journal entry is:
| Account | Debit | Credit |
|---|---|---|
| Depreciation Expense A/c | ₹90,000 | |
| Accumulated Depreciation A/c | ₹90,000 |
Depreciation expense reduces the profit reported in the statement of profit and loss.
Accumulated depreciation is deducted from the relevant asset’s gross carrying amount in determining its net carrying amount.
For example:
| Particulars | Amount |
|---|---|
| Machinery cost | ₹5,00,000 |
| Less: Accumulated depreciation | ₹90,000 |
| Net Carrying Amount | ₹4,10,000 |
This is how depreciation affects both the profit and loss account and the balance sheet.
Depreciation Under the Companies Act and Income Tax Act
For Indian businesses, it is important to distinguish depreciation used for financial reporting from depreciation calculated for income-tax purposes.
Depreciation Under the Companies Act, 2013
Schedule II of the Companies Act, 2013 provides a framework for determining useful lives of tangible assets for applicable companies.
Depreciation is calculated by allocating the depreciable amount over the asset’s useful life.
The applicable accounting standards also guide the selection and application of depreciation methods.
Under Ind AS 16, depreciation methods include the Straight Line Method, Diminishing Balance Method and Units of Production Method.
The method should reflect the expected pattern of consumption of the asset’s future economic benefits.
Depreciation Under the Income Tax Act
Depreciation for income-tax purposes is governed by the applicable provisions of the Income-tax Act and related rules.
Tax depreciation commonly uses the Written Down Value approach for prescribed blocks of assets, subject to applicable provisions and exceptions.
The depreciation rates used for tax purposes may differ from those used in financial statements.
Therefore, students should not assume that the same depreciation rate or method applies automatically to both accounting profit and taxable income.
Important: The illustrative 20% WDV rate used earlier is not a statement of the tax depreciation rate applicable to any particular asset.
Common Mistakes Students Make in Depreciation Calculations
Ignoring Residual Value
Residual value represents the estimated amount recoverable from an asset at the end of its useful life, after relevant disposal costs.
It must be considered when determining the depreciable amount.
Confusing Cost with Carrying Amount
Under the Straight Line Method, depreciation is generally based on the depreciable amount allocated over useful life.
Under WDV, depreciation is calculated using the reducing carrying amount.
Using the Same WDV Amount Every Year
Under WDV, depreciation generally decreases each year because the opening carrying amount becomes smaller.
Applying the first year’s depreciation amount repeatedly would not follow the reducing-balance method.
Assuming Depreciation Is a Cash Expense
Depreciation reduces accounting profit but does not itself involve an annual cash payment.
The asset purchase and depreciation expense are separate accounting events.
Assuming Every Asset Must Be Depreciated
Not all assets are depreciated.
For example, land generally has an unlimited useful life and is normally not depreciated, although exceptions can arise depending on the nature and use of the asset.
Choosing a Method Only to Reduce Profit
Depreciation methods should reflect the expected consumption of economic benefits and comply with applicable accounting requirements.
They should not be changed arbitrarily to manipulate financial results.
Why CA and CMA Students Should Understand Depreciation Methods
For CA students, depreciation is an important concept in financial accounting, financial reporting, auditing and taxation.
Students must understand how depreciation is calculated, recorded and presented in financial statements.
During practical accounting and audit assignments, they may also examine fixed asset registers, useful-life estimates and accumulated depreciation.
For CMA students, depreciation is relevant to cost accounting, product costing, budgeting and investment decisions.
For example, depreciation on production machinery may form part of manufacturing overheads, depending on the costing approach used.
Understanding how asset costs are allocated helps students interpret product costs and business profitability.
For commerce students, the key lesson is that depreciation is not simply a reduction in asset value. It is a systematic accounting process used to allocate the cost of an asset over the periods that benefit from its use.
Build Stronger Financial Accounting Skills with Master Minds India
Understanding depreciation methods helps students connect asset accounting with profit measurement, financial reporting and business cost analysis. Learning when to apply SLM, WDV and Units of Production makes it easier to interpret financial statements and solve accounting problems accurately.
Master Minds India provides educational resources for students pursuing commerce and professional accounting studies. Explore the available Master Minds courses to learn more about the educational programmes.
