As the name of the method implies, under fixed installment method of depreciation the amount of depreciation each year is fixed and equal. At the end of each year, a fixed amount is removed from the book value of the asset concerned and charged to profit and loss account (or income statement).
There are certain assets that give more or less the same service over their entire life, and when their useful life is over, they are of no value to the owners. A good example is a leasehold property. If a businessman acquires a property on a 100 years lease, the property would be of no value to him after 100 years as it would return to the original owner. For such a fixed asset, depreciation per year is arrived at by dividing its cost over the number of years it is expected to have a useful life of.
ABC company acquired a plot on a 100 years lease for $125,000. Calculate the plot’s depreciation per year.
Depreciation per year = $125,000/100 years
Scrap or residual value
Most fixed assets, however, have some value left even after their useful life is over. For example, if a trader buys a machine which is expected to have a useful life of 10 years, it is likely that after 10 years, even though the machine may not be active and useful it will still be worth a few dollars as scrap. This amount is called asset’s scrap or residual value. For assets that are likely to leave a scrap value, depreciation per year is calculated by using the following formula:
The ABC company purchased a machine for $124,000. It is expected to last for 6 years and leave a scrap value of $4,000. Calculate its depreciation per year.
Depreciation per year = ($124,000 – $4,000)/6 years
Trade in value
Some businessmen prefer not to keep their fixed assets till the end of their useful life but to sell them off when they are still in working order. The price fetched then is called resale value, or if the asset is traded in for a new one, trade-in value. For such assets, depreciation per year is calculated as follows:
The XYZ company bought a machine for $124,000. It expects to use it for 5 years and sell it for $34,000. Calculate its depreciation per year.
Depreciation per year = ($124,000 – $34,000)/5 years
The fixed installment method is also known as the straight line method. It is particularly suitable for such assets that give more or less the same service over their entire useful life and whose useful life and whose useful life can be ascertained to a fair degree of accuracy. Examples of such assets are leasehold property, large machinery and plants, mines, etc.