How to calculate depreciation (straight-line & reducing-balance)

Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements

What you need

• The original cost of the asset and its date of purchase.
• The residual (scrap) value and useful life, or the fixed percentage rate of depreciation.
• The chosen depreciation method: straight-line or reducing-balance.
• The accumulated depreciation brought forward from prior years (if the asset is not new).

Step by step

1. 1

   Gather the asset details

   Record all details of the asset. Example: On 1 January 2023, Perniagaan Setia bought a packaging machine for RM50,000, paid by bank. The purchase entry is Debit Machine RM50,000; Credit Bank RM50,000. The residual value is estimated at RM5,000 and the useful life is 5 years. For the reducing-balance method, the fixed rate is 20% per year. These figures form the basis of every calculation.

2. 2

   Understand the two methods

   The straight-line method charges the same amount of depreciation each year, based on cost minus residual value. The reducing-balance method applies a fixed percentage rate to the net book value (remaining balance) each year, so the yearly charge gets smaller over time. Important: the residual value is NOT deducted under the reducing-balance method.

3. 3

   Calculate straight-line depreciation

   Use the formula: Annual Depreciation = (Cost - Residual Value) / Useful Life. For Perniagaan Setia's machine: (RM50,000 - RM5,000) / 5 = RM9,000 per year. This RM9,000 is charged equally every year for 5 years until the net book value reaches the residual value of RM5,000.

4. 4

   Calculate reducing-balance depreciation

   Use the formula: Depreciation = Rate % x Net Book Value at the start of the year. Take the same machine at a rate of 20%. Year 1: 20% x RM50,000 = RM10,000 (NBV RM40,000). Year 2: 20% x RM40,000 = RM8,000 (NBV RM32,000). Year 3: 20% x RM32,000 = RM6,400 (NBV RM25,600). Notice the charge falls each year.

5. 5

   Build the accumulated depreciation schedule

   Accumulated depreciation is the running total of depreciation up to the current date. Under straight-line: end of Year 1 accumulated RM9,000 (NBV RM41,000); end of Year 2 accumulated RM18,000 (NBV RM32,000); end of Year 3 accumulated RM27,000 (NBV RM23,000). Add the current year's charge to last year's accumulated balance.

6. 6

   Record the double entry

   At the year end, record the depreciation expense. For the first straight-line year: Debit Depreciation Expense (Machine) RM9,000; Credit Accumulated Depreciation (Machine) RM9,000. Remember, we credit the Accumulated Depreciation account, NOT the Machine asset account directly, so the original cost of the asset stays in the books.

7. 7

   Transfer to the financial statements

   Transfer the depreciation expense to the expenses section of the Income Statement (Year 2: RM9,000). In the Statement of Financial Position at the end of Year 2, show the Machine at cost RM50,000, less Accumulated Depreciation RM18,000, giving a Net Book Value of RM32,000 under non-current assets.

Second example

A second example shows how the two methods differ. On 1 January 2024, Kedai Harmoni bought a computer for RM8,000. Using the reducing-balance method at a rate of 25%: Year 1 depreciation is 25% x RM8,000 = RM2,000 (NBV RM6,000), and Year 2 is 25% x RM6,000 = RM1,500 (NBV RM4,500). Accumulated depreciation at the end of Year 2 is RM3,500. The Year 1 double entry is: Debit Depreciation Expense (Computer) RM2,000; Credit Accumulated Depreciation (Computer) RM2,000.

If Kedai Harmoni instead chose the straight-line method with a residual value of RM500 and a useful life of 5 years, annual depreciation would be (RM8,000 - RM500) / 5 = RM1,500, the same every year. Compare: the reducing-balance method charges more in the early years (RM2,000), while straight-line is more even (RM1,500). The choice of method depends on the usage pattern of the asset.

Common mistakes

Related chapter: Adjustments at the Balance Date and Preparation of Sole Proprietorship Financial Statements →

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