Depreciation spreads the cost of an asset over the years it is useful, instead of charging all of it in the year you bought it. The question every finance team faces is how to spread it. The two methods you will meet most are straight-line and reducing balance, and the difference is simple: straight-line charges the same amount each year, and reducing balance charges more early and less later.
This article works one example through both methods, in Kenyan shillings, so you can see exactly what each does.
The words you need
- Cost: what the asset cost to acquire and bring into use.
- Residual value: what you expect it to be worth at the end of its useful life.
- Useful life: how long you expect to use it.
- Depreciable amount: cost less residual value. This is the amount that is spread.
- Net book value (NBV): cost less accumulated depreciation. What the asset is carried at.
The example
A delivery van, bought and put into use on the first day of the financial year.
| Cost | KES 2,400,000 |
| Residual value | KES 400,000 |
| Useful life | 5 years |
| Depreciable amount | KES 2,000,000 |
Straight-line
The same charge every year:
(cost − residual value) ÷ useful life = (2,400,000 − 400,000) ÷ 5 = 400,000
| Year | Depreciation | Net book value at year end |
|---|---|---|
| 1 | 400,000 | 2,000,000 |
| 2 | 400,000 | 1,600,000 |
| 3 | 400,000 | 1,200,000 |
| 4 | 400,000 | 800,000 |
| 5 | 400,000 | 400,000 |
After five years the van is carried at its residual value, which is what we assumed it would be worth.
Where it fits. Assets whose usefulness falls steadily with time: furniture, buildings, ordinary office equipment. It is the easiest to explain, to check and to reproduce.
Reducing balance
A fixed percentage of the net book value at the start of each year. Using 30% for this van:
| Year | Opening NBV | Depreciation (30%) | Closing NBV |
|---|---|---|---|
| 1 | 2,400,000 | 720,000 | 1,680,000 |
| 2 | 1,680,000 | 504,000 | 1,176,000 |
| 3 | 1,176,000 | 352,800 | 823,200 |
| 4 | 823,200 | 246,960 | 576,240 |
| 5 | 576,240 | 172,872 | 403,368 |
Two things to notice. The charge is largest in year 1 and falls every year. And the closing value after year 5, KES 403,368, is close to the residual value of KES 400,000: a rate of about 30% is what takes this van from 2,400,000 to roughly 400,000 in five years. The exact rate that lands on the residual value is 1 − (residual ÷ cost)^(1 ÷ life), which here is about 30.1%.
Where it fits. Assets that lose more of their value, or give more of their service, early: vehicles, computers, equipment that becomes outdated quickly.
Side by side
| Year | Straight-line | Reducing balance (30%) |
|---|---|---|
| 1 | 400,000 | 720,000 |
| 2 | 400,000 | 504,000 |
| 3 | 400,000 | 352,800 |
| 4 | 400,000 | 246,960 |
| 5 | 400,000 | 172,872 |
| Total | 2,000,000 | 1,996,632 |
The totals are almost the same. Over the life of an asset, both methods charge the depreciable amount. The difference is when. Reducing balance brings more expense into the early years and leaves less for the later ones, which also means the book value falls faster at the start.
Two other methods you will see
Double declining balance
A reducing balance method that uses twice the straight-line rate: for a 5-year life, 2 ÷ 5 = 40%. It never takes the book value below the residual value.
| Year | Depreciation | Closing NBV |
|---|---|---|
| 1 | 960,000 | 1,440,000 |
| 2 | 576,000 | 864,000 |
| 3 | 345,600 | 518,400 |
| 4 | 118,400 | 400,000 |
| 5 | 0 | 400,000 |
By year 4 the book value has reached the residual value, so the charge is limited to what is left, and year 5 has none.
Sum-of-the-years’-digits
Each year’s charge is the depreciable amount multiplied by the years remaining over the sum of the digits of the life (1+2+3+4+5 = 15):
| Year | Fraction | Depreciation | Closing NBV |
|---|---|---|---|
| 1 | 5 ÷ 15 | 666,667 | 1,733,333 |
| 2 | 4 ÷ 15 | 533,333 | 1,200,000 |
| 3 | 3 ÷ 15 | 400,000 | 800,000 |
| 4 | 2 ÷ 15 | 266,667 | 533,333 |
| 5 | 1 ÷ 15 | 133,333 | 400,000 |
Part-year assets
Few assets are bought on the first day of the year. If the van had been put into use on 1 October, with a calendar financial year, it is in use for three months. On a monthly basis under straight-line:
400,000 ÷ 12 = 33,333 a month, so 3 × 33,333 = 100,000 in the first year
Your policy decides the convention for the first month: the full month, the half month, or the actual days. Whichever you choose, apply it to every asset, so that the register reproduces.
Choosing, in practice
- Start with your accounting policy and your standards. Public bodies, NGOs and companies may have rules, or a prescribed rate per category.
- Pick the method that follows the pattern of use, and apply it consistently by category.
- Do not change method to improve a result. A change is a change in estimate, and it must be justified and disclosed.
- Keep it reproducible. Whoever opens the schedule next year should get the same numbers from the same inputs.
That last point is where spreadsheets struggle. A formula that breaks when a row moves, or a useful life that someone changed in a copy, makes last year’s depreciation impossible to recreate. VexCloud AMS stores the policy version an asset started with, calculates from a fixed engine, and posts to a ledger that cannot be edited, so a schedule can be reproduced at any time.
Checking your own schedule
Whichever method you use, three checks catch most mistakes:
- Does the total equal the depreciable amount? Over the whole life, the charges should add up to cost less residual value, no more and no less.
- Does the book value ever go below the residual value? It should not. Reducing balance methods need a floor, so that the last years are capped at what is left.
- Does the schedule stop? Depreciation ends when the asset is fully depreciated, disposed of or retired. A schedule that keeps charging a disposed asset overstates expense.
When an asset is disposed of part-way through its life, depreciate it up to the date of disposal, then compare the proceeds with the book value at that date. Proceeds above book value are a gain; below are a loss. In VexCloud AMS the final depreciation, the book value and the gain or loss are worked out when the disposal is completed, and a numbered certificate is produced.
A note on tax
Book depreciation is not the tax allowance. In Kenya, capital allowances such as wear and tear follow the tax rules and are computed separately, and they depend on assets you can show physically. We cover that link in Vexar’s guide to how wear-and-tear allowances relate to physical fixed asset tagging. For rates and classes, ask your tax adviser.
Questions
Which method should we use?
Use the method that best matches how the asset's benefit is used up, and apply it consistently. For most office, IT and furniture assets, straight-line is the common choice because it is simple and predictable. Your accounting policy and your auditors have the final say.
Is the depreciation in the accounts the same as the allowance for tax?
No. Book depreciation follows your accounting policy. Tax capital allowances follow the tax rules and are computed separately. This article is about book depreciation; confirm the tax treatment with your tax adviser.
What happens if I buy an asset part-way through the year?
You normally charge only the months it was in use. With the monthly method, an asset in service from 1 October has three months of depreciation in a calendar year. Your policy decides the convention for the first month.
Can I change the method later?
A change of method is a change in accounting estimate. It is applied from the change onwards, spreading the remaining book value, and earlier periods are not restated.