Evaluate Industry Performance to Determine Stock Value
How Companies Classify Expenses
Examining Purchase Procedures for Risk

How to Check Depreciation Calculations

There are a few different ways that your audit client might use to figure depreciation. In addition to understanding depreciation accounting methods, when doing an audit, you need to know the following numbers before you start checking depreciation calculations:

  • The asset’s cost

  • How long the company anticipates being able to use the asset

  • The asset’s value after the company is done using it

Under GAAP, fixed assets are depreciated using one of four methods: straight-line, units of production, declining balance, and sum-of-the-years’ digits. The method your client uses is a matter of choice as long as the method is appropriate for the asset.

  • Straight-line depreciation: The cost of the asset less its salvage value is divided by its useful life.

  • Units of production depreciation: The cost of the asset less its salvage value is divided by number of units (mileage in the case of a vehicle). Then, that figure is multiplied by the number of units for the year (or miles put on a vehicle during the year).

  • Declining balance depreciation: The straight-line depreciation rate is doubled and multiplied by the asset’s book value at the beginning of the year. You don’t use salvage value.

  • Sum-of-the-years’ digits depreciation: This method is no longer widely used, so here’s just a brief overview: You depreciate the asset by adding the useful life years together (5 + 4 + 3 + 2 + 1 = 15). In year one, your multiplier is 5/15 (1/3); in year two, the multiplier is 4/15; and so on. Using this method, you calculate depreciation using the asset’s cost less its salvage value. For the FPD van, the first-year depreciation expense is $8,333 ($25,000/3).

Your client can’t arbitrarily switch methods after it has started using one method for an asset. Doing so is considered a change in accounting principle, and under GAAP, the change must be disclosed and accounted for in a particular fashion.

Financial statement depreciation methods are different from tax depreciation methods. If you’ve ever owned a business or done the tax return for a business, you’ve most likely used either the Modified Asset Cost Recovery System (MACRS) or special expensing depreciation such as Internal Revenue Code (IRC) 179. You can find information about both on the Internal Revenue Service Web site. In the search box in the upper right-hand side of the home page, enter “Publication 946” to bring up links for this publication.

blog comments powered by Disqus
The Derivatives Market in the World of Corporate Finance
Engineering Corporate Finances
Following Long-Term Debt Audit Procedures
What Are Chips, Caps, and Sectors in the World of Corporate Finance?
How to Test Dividends

Inside Dummies.com