IAS 16 · ASC 360 · IRS MACRS
Depreciation & Its Methods: A Complete Guide
Depreciation turns the one-off cost of a long-lived asset into a steady expense that follows the asset across its working life. The method you choose decides how fast that cost hits the income statement — and therefore your reported profit, asset values, and tax. This guide explains what depreciation is, why it exists, the main methods with worked examples, and how to pick the right one.
1What is Depreciation?
Depreciation is the systematic allocation of the cost of a tangible fixed asset, less its residual value, over the periods that benefit from its use. It is not an attempt to track the asset's market price — it is a way of charging the asset's cost to the periods that consume its economic benefits.
IAS 16 §6 — Definition
"Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life." — IAS 16, paragraph 6
Two consequences follow. First, depreciation is a non-cash expense — the cash left the business when you bought the asset; depreciation simply spreads that cost across later periods. Second, land is not depreciated, because it has an indefinite useful life. Depreciation begins when an asset is available for use and continues until it is derecognised or fully depreciated, even during idle periods.
2Why Do We Depreciate Assets?
Charging the full cost of a building or machine to the year you bought it would crush that year's profit and overstate every year after. Depreciation exists to prevent exactly that distortion — and it serves several purposes at once:
The matching principle
Revenue earned with the help of an asset should be matched against a share of that asset's cost in the same period. Depreciation spreads the cost across the years the asset actually generates income, so profit reflects the true cost of doing business.
Faithful asset values
The balance sheet should show what an asset is worth to the business, not what it cost years ago. Accumulated depreciation reduces the carrying amount each period to reflect the economic benefit already consumed.
Standards compliance
IAS 16 (IFRS) and ASC 360 (US GAAP) require the depreciable amount of every qualifying asset to be allocated systematically over its useful life. Skipping depreciation is a reporting error, not a choice.
Better operating decisions
Accurate depreciation feeds repair-vs-replace analysis, product pricing, capital budgeting, and ROI calculations. Under-depreciating hides the true cost of ageing assets and delays replacement decisions.
Tax relief
Most tax regimes let businesses deduct depreciation (or capital allowances such as MACRS) against taxable income, reducing the tax bill. Tax depreciation often follows its own rules and is tracked in a separate tax book.
3The Depreciation Methods
IAS 16 §60 requires the method to reflect the pattern in which the asset's economic benefits are consumed. Several methods do that in different ways — some spread the cost evenly, some front-load it, and one ties it to actual output. The table summarises them; detailed cards with worked examples follow.
| Method | Expense Pattern | Standard |
|---|---|---|
| Straight-Line (SL) | Equal charge every year | IAS 16 §62 |
| Declining Balance / Double-Declining (DDB) | Accelerated — front-loaded | IAS 16 §62 |
| Sum-of-the-Years'-Digits (SYD) | Accelerated — smoother | IAS 16 §62 |
| Units of Production (UOP) | Usage-based — varies with output | IAS 16 §62 |
Worked example asset — Every example below uses the same asset: a machine costing $50,000, with an estimated residual (salvage) value of $5,000, a useful life of 5 years, and total expected output of 100,000 units. The depreciable amount is therefore $50,000 − $5,000 = $45,000.
Straight-Line
SL(Cost − Residual Value) ÷ Useful LifeHow it works: Spreads the depreciable amount evenly across every year of the asset's useful life. It is the simplest and most widely used method, and it is appropriate whenever an asset delivers its benefits at a roughly constant rate over time.
Worked example
($50,000 − $5,000) ÷ 5 years = $9,000 of depreciation charged every year, until the carrying amount reaches the $5,000 residual value.
Best suited to: Buildings, furniture and fixtures, and most assets whose economic benefit is consumed steadily and predictably over time.
Declining Balance / Double-Declining
DDBNet Book Value × Rate (DDB rate = 2 ÷ Useful Life)How it works: An accelerated method that applies a fixed percentage to the asset's reducing net book value, so the charge is largest in the early years and tapers off. Double-declining balance uses twice the straight-line rate. Residual value is not subtracted from the base, but depreciation stops once net book value reaches residual value.
Worked example
DDB rate = 2 ÷ 5 = 40%. Year 1: $50,000 × 40% = $20,000. Year 2: $30,000 × 40% = $12,000. Year 3: $18,000 × 40% = $7,200 — and so on, never depreciating below the $5,000 residual value.
Best suited to: Assets that lose value quickly or are most productive when new — vehicles, IT hardware, and technology subject to rapid obsolescence.
Sum-of-the-Years'-Digits
SYD(Remaining Life ÷ Σ Years' Digits) × Depreciable AmountHow it works: Another accelerated method, but more gradual than declining balance. The depreciable amount is multiplied each year by a fraction whose numerator is the remaining life and whose denominator is the sum of the years' digits.
Worked example
Sum of the digits for a 5-year life = 5+4+3+2+1 = 15. Year 1: 5/15 × $45,000 = $15,000. Year 2: 4/15 × $45,000 = $12,000. Year 3: 3/15 × $45,000 = $9,000 — declining smoothly toward the residual value.
Best suited to: Assets with high early productivity where a moderate, predictable acceleration is preferred over the steeper curve of double-declining balance.
Units of Production
UOP(Depreciable Amount ÷ Total Est. Units) × Units This PeriodHow it works: Ties the charge to actual output rather than the passage of time. A per-unit rate is calculated once, then applied to the units produced each period. The expense rises and falls with usage and is zero in a period when the asset sits idle.
Worked example
Rate = $45,000 ÷ 100,000 units = $0.45 per unit. Produce 18,000 units in year 1 → $8,100. Produce 22,000 units in year 2 → $9,900. Total depreciation can never exceed the $45,000 depreciable amount.
Best suited to: Machinery, mining and quarrying assets, and fleet vehicles where wear tracks usage. A machine-hours variant works the same way using hours instead of units.
MACRS — The Modified Accelerated Cost Recovery System is the mandatory accelerated method for US federal tax depreciation (IRS Publication 946). It uses prescribed class lives and rate tables and is not permitted for IFRS or US-GAAP financial reporting — entities that use it keep a separate tax book alongside their accounting book.
4Selecting a Depreciation Method
There is no single 'correct' method for every asset. The choice is a judgement, but IAS 16 narrows it to methods that genuinely reflect how the asset is used. Work through these points:
Match the consumption pattern
Choose the method that best reflects how the asset's economic benefits are actually consumed (IAS 16 §60). Even benefit → straight-line; heaviest in the early years → declining balance or sum-of-the-years'-digits; driven by output → units of production.
Revenue-based methods are prohibited
A method based on revenue generated by an activity that includes the use of the asset is not allowed (IAS 16 §62A). Revenue reflects factors such as selling prices and volumes that have nothing to do with how the asset itself is consumed.
Weigh simplicity against accuracy
Straight-line is easy to apply, audit, and explain, which is why most entities use it as a default. Accelerated and usage-based methods are more faithful for certain assets but add complexity and data requirements — only worth it when the pattern is materially different.
Apply it consistently, then review
Apply the chosen method consistently from period to period. Review it at least at each year-end; if the expected pattern of consumption has changed, change the method and account for it prospectively as a change in accounting estimate (IAS 16 §61).
Keep tax and book separate
The method that is best for financial reporting is rarely the one tax law mandates. Maintain a separate tax depreciation book (e.g., MACRS or local capital allowances) rather than letting tax rules distort your financial statements.
IAS 16 §61–62A — The depreciation method must be reviewed at least at each financial year-end and changed if the expected pattern of consumption has changed; such a change is accounted for prospectively as a change in accounting estimate. A depreciation method based on the revenue an asset generates is explicitly prohibited.