# How to Calculate Activity Based Depreciation

How to Calculate Activity Based Depreciation

Depreciation is an important concept in accounting that allows businesses to allocate the cost of an asset over its useful life. Activity based depreciation is a method used to calculate depreciation based on the actual usage or activity of the asset. This method provides a more accurate representation of the asset’s value as it takes into account the wear and tear it undergoes due to its usage. In this article, we will discuss how to calculate activity based depreciation and answer some frequently asked questions about this method.

Calculating Activity Based Depreciation:

Step 1: Determine the total cost of the asset
To calculate activity based depreciation, you need to know the total cost of the asset. This includes the purchase price, transportation costs, installation fees, and any other costs related to acquiring the asset.

Step 2: Estimate the total activity or usage of the asset
Next, you need to estimate the total activity or usage of the asset over its useful life. This could be measured in terms of hours, miles, units produced, or any other relevant measure depending on the nature of the asset. For example, if you are calculating activity based depreciation for a machine, you might use the number of hours it operates.

Step 3: Determine the useful life of the asset
The useful life of an asset refers to the period over which it is expected to provide economic benefits. This can be determined based on industry standards, manufacturer recommendations, or past experience. For example, if a machine is expected to be useful for 10 years, its useful life would be 10 years.

Step 4: Calculate the depreciation rate per unit of activity
To determine the depreciation rate per unit of activity, divide the total cost of the asset by the estimated total activity or usage. For example, if the total cost of a machine is \$50,000 and the estimated total activity is 10,000 hours, the depreciation rate per hour would be \$5 (\$50,000 / 10,000 hours).

Step 5: Calculate the annual depreciation expense
To calculate the annual depreciation expense, multiply the depreciation rate per unit of activity by the actual activity or usage for the year. For example, if the machine was used for 1,000 hours in a year, the annual depreciation expense would be \$5,000 (\$5 x 1,000 hours).

Step 6: Repeat the calculation for each year
Repeat the calculation for each year of the asset’s useful life to determine the annual depreciation expense. Adjust the estimated activity or usage if necessary based on actual data.

Q: Why is activity based depreciation more accurate than other methods?
A: Activity based depreciation is more accurate because it considers the actual usage or activity of the asset. It provides a more precise measure of the asset’s wear and tear, resulting in a more accurate depreciation expense.

Q: Can activity based depreciation be used for all types of assets?
A: Yes, activity based depreciation can be used for all types of assets as long as there is a measurable activity or usage associated with the asset. It is particularly useful for assets that experience varying levels of usage.

Q: What are the limitations of activity based depreciation?
A: Activity based depreciation relies on accurate estimation of the total activity or usage of the asset. If this estimation is incorrect, the depreciation expense may be inaccurate. Additionally, activity based depreciation may not be suitable for assets with unpredictable patterns of activity.

Q: How does activity based depreciation affect financial statements?
A: Activity based depreciation reduces the value of the asset over time, resulting in lower net income and lower asset value on the balance sheet. It also increases the accumulated depreciation account on the balance sheet.

Q: Is activity based depreciation accepted by accounting standards?
A: Yes, activity based depreciation is an accepted method of calculating depreciation under generally accepted accounting principles (GAAP) and international financial reporting standards (IFRS).

In conclusion, activity based depreciation provides a more accurate way to calculate depreciation by considering the actual activity or usage of an asset. By following the steps outlined in this article, businesses can accurately determine the annual depreciation expense and reflect the true value of their assets.