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Depreciation is technique companies use to depreciate assets over their useful life. Usually, it consists of the straight-line method that divides the asset’s cost over that life. However, other depreciation methods also allow companies to comply with the accounting standards’ requirements. They are not as common as the straight-line method for depreciating assets.
One of the uncommon depreciation methods used by companies is activity-based depreciation. It follows a similar base to depreciating assets as activity-based costing in managerial accounting. In this case, though, the objective is different.
What is the Activity-Based Depreciation Method?
Activity-Based Depreciation (ABD) is a method of calculating the depreciation of an asset based on its usage or activity. This method evaluates how much an asset is used in its life rather than just the passage of time. Unlike the straight-line method, it does not consider the asset’s useful life. Instead, it bases depreciation on the asset’s activity, which can be more accurate in some cases.
With activity-based depreciation, companies can depreciate assets more consistently. It also results in a more accurate depreciation for assets that wear down with more usage. However, it may require more work to determine an asset’s usage over time. The calculation for this method also differs from other methods. However, it is not as common as the others used in accounting.
How is the Activity-Based Depreciation Method different from others?
Activity-based depreciation takes into account the usage or activity of an asset rather than just time or the passage of time. Given below are some of the differences between this method and the others.
Straight-Line Depreciation
The straight-line depreciation method calculates depreciation as a fixed percentage of the asset’s original cost over the asset’s useful life. This method assumes that the asset depreciates evenly over time, regardless of the usage.
Double-Declining Balance Depreciation
The double-declining balance depreciation method calculates depreciation as a fixed percentage of the remaining book value of the asset each year. This method assumes that the asset depreciates more heavily in the early years and less in later years.
Sum-of-the-Years’-Digits Depreciation
The sum-of-the-years’-digits depreciation method calculates depreciation as a variable percentage of the asset’s original cost over its useful life. It results in heavier weighting in the earlier years.
How to calculate depreciation under the Activity-Based Depreciation Method?
Companies can use the formula for activity-based depreciation method to depreciate an asset. It may require some estimation initially. On top of that, it also entails determining the actual usage for that asset after every period. Nonetheless, the activity-based depreciation method formula is as below.
Depreciation cost = (Asset’s cost – Salvage value) / Estimated output for the asset x Units produced during the period
For example, Blue Co. purchases an asset with an estimated output over a lifetime of 100,000 units. Its cost minus salvage value is $300,000. During this period, Blue Co. used the asset to produce 20,000 items. Under the activity-based depreciation method, the depreciation cost for that asset would be as follows.
Depreciation cost = (Asset’s cost – Salvage value) / Estimated output for the asset x Units produced during the period
Depreciation cost = $300,000 / 100,000 x 20,000
Depreciation cost = $60,000
Conclusion
The activity-based depreciation method calculates an asset’s depreciation cost based on its activity or usage. It differs from other depreciation methods that result in linear or inconsistent depreciation. However, it may require a company to estimate the asset’s lifetime expected output. The activity-based depreciation method is not as common as the others mentioned above.
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