What are the depreciation methods

Depreciation Method - What is a Depreciation Method?

The depreciation method describes the way in which the impairment of assets in an enterprise is recorded.

Find out in our article how to carry out depreciation correctly.

The depreciation method records the scheduled depreciation of a company's assets. It describes the loss in value of an asset that occurs over the period of use, for example through wear and tear.

Depreciation methods HGB

which assets may be depreciated is defined in Section 253, Paragraphs 2 - 4 of the German Commercial Code. The rule here is that the goods must be usable for a limited period of time or, however, must be written off according to a reasonable commercial assessment. Depreciation based on tax depreciation is also made possible by Section 254 of the German Commercial Code (e.g. depreciation for low-value assets).

What are the depreciation methods?

In order to record the loss in value of an asset in the course of its use, different depreciation methods could be used for depreciation until some time ago.

Possible depreciation methods were:

  • Linear depreciation
  • Declining balance depreciation
  • Combined depreciation
  • Progressive depreciation
  • Performance-related depreciation / depreciation

The type of depreciation method is often not freely selectable for accounting, but is prescribed by the legislator. The currently only valid depreciation method is straight-line depreciation.

The different depreciation methods are explained below.

Straight-line depreciation - currently valid depreciation method

With straight-line depreciation, the cost of an item is distributed evenly over its useful life. It is therefore assumed that an asset wears out evenly over its useful life and thus loses value evenly. This is the case, for example, when a machine is used more or less equally over its entire service life due to stable demand.

Example: straight-line depreciation method

A machine that costs 50,000 euros and is to be used for 5 years is depreciated by 10,000 euros every year using the straight-line depreciation method.

In this case, the depreciation schedule would look like this:

perioddepreciationresidual value
0050.000
110.000 (=50.000*20 %)40.000
28.000 (=40.000*20 %)32.000
36.400 (=32.000*20 %)25.600
4......

According to linear depreciation, after the first year of use the machine is worth only € 40,000, after the second year of use only € 30,000, etc.

Note: The straight-line depreciation is currently the only tax depreciation method.

Declining balance depreciation - alternative method of depreciation

With declining balance depreciation, a certain percentage of the residual value from the previous year is depreciated in each period. The depreciation amount falls steadily - so the first years of use are more heavily burdened by depreciation. This method was therefore used, for example, for machines from production that are used more frequently in the early years due to strong demand - and are therefore subject to greater wear and tear - than later.

Since with this method only part of the residual value is written off, the value of the object in question can never drop to 0.

The types of declining balance depreciation include:

  • Geometric degressive depreciation
  • Arithmetic degressive depreciation

Example: Geometric degressive depreciation method

So if we look again at the machine with an acquisition value of 50,000 euros, but it is now depreciated by 20% annually, the depreciation plan looks like this:

periodScrews produceddepreciationresidual value
00050.000
115.000 (=50.000*30 %)10.000 (=50.000/5)35.000
210.500 (=35.000*30 %)8.750 (=35.000/4)24.500
37.3508.167 (24.500/3)16.333
44.9008.1678.166
52.4508.1670

After the first year of depreciation, the value of the machine drops to € 35,000. In the following years, the value fell less and less quickly due to decreasing demand.

In addition to the geometrical-degressive depreciation, in which the depreciation amount decreases annually by the same percentage, there is also another form of the degressive depreciation: the arithmetic-degressive depreciation. The depreciation amount decreases by the same amount each year.

Note: Depreciation using the declining balance method is currently not permitted.

Progressive depreciation - alternative method of depreciation

Progressive depreciation is exactly the opposite of declining balance depreciation: it leads to annual increasing depreciation amounts. Their use was extremely rare and usually only played a role in exceptional cases, for example in systems that are gradually started up, e.g. power plants.

Variants of the progressive depreciation method are geometric progressive depreciation and arithmetic progressive depreciation.

Note: Depreciation using the progressive depreciation method is currently not permitted.

Combined depreciation - a combination of several depreciation methods

According to this depreciation method, different depreciation methods are combined, e.g. the declining balance depreciation is started and then, after a while, the straight-line depreciation is used.

As a rule, the declining balance straight-line depreciation is converted in the period in which the straight-line depreciation is above the declining balance depreciation for the first time.

For some time this method of depreciation was allowed for tax purposes. For the entrepreneurs, this had the advantage that they could claim costs earlier than with the straight-line depreciation method and therefore reduce their tax burden in the first few years of use.

Note: Depreciation using the combined depreciation method is currently not permitted.

Performance-based depreciation - flexible depreciation method

With performance-related depreciation / amortization, the costs of an asset are distributed over the periods of use depending on their performance. It therefore reflects the actual wear and tear of an asset, which can be stronger or weaker depending on the intensity of use. To do this, it is necessary to know not only the expected service life, but also the overall performance of the machine.

Example: service-related depreciation method

Again, our machine worth 50,000 euros will serve as an example.

We now also know that the machine can produce a total of 50,000 screws in its service life. For each screw produced in a period, a depreciation of one euro is made. The depreciation schedule now looks like this:

periodScrews produceddepreciationresidual value
00050.000
112.00012.00038.000
211.00011.00027.000
35.0005.00022.000
412.00012.00010.000
510.00010.00010.000

Analogous to the number of screws produced, the machine is written off more or less every year.

Note: Depreciation according to the performance-related depreciation method is currently not permitted.

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similar words

depreciation

acquisition cost

Cost accounting