How is depreciation calculated and reported in financial statements?

Depreciation is calculated using methods like straight-line, declining balance, or units of production, and reported under expenses in financial statements.

Depreciation is a method of allocating the cost of a tangible asset over its useful life. Businesses depreciate long-term assets for both tax and accounting purposes. The former affects the balance sheet of a business or company, and the latter affects the net income that they report. There are several methods to calculate depreciation, including the straight-line method, the declining balance method, and the units of production method.

The straight-line method is the simplest and most commonly used. It spreads the cost of the asset evenly over its useful life. For example, if a company buys a machine for £10,000 and expects it to last for 10 years, the annual depreciation would be £1,000 (£10,000 / 10 years).

The declining balance method, on the other hand, accelerates depreciation, so more cost is recognised in the early years of an asset's life. This is useful for assets that lose value quickly. The units of production method calculates depreciation based on the actual usage of the asset, which can be more accurate but also more complex to calculate.

Depreciation is reported in the financial statements under expenses. It is subtracted from gross profit in the income statement to arrive at operating profit. In the balance sheet, it is subtracted from the asset's original cost in the non-current assets section to show the asset's net book value.

It's important to remember that depreciation is an estimate, not a precise measurement. It's based on assumptions about an asset's useful life and residual value, which may not reflect reality. Therefore, different companies may report different amounts of depreciation for similar assets, depending on their policies and estimates.