The difference between SLM and WDV refers to two common methods of calculating depreciation: the Straight Line Method (SLM) and the Written Down Value (WDV) method. Depreciation is the systematic allocation of the cost of a tangible asset over its useful life. Businesses use depreciation to account for the gradual loss of value in the assets, thereby aiding in determining the accurate performance and position of the business. Understanding the difference between SLM and WDV is very important when choosing the right depreciation method to apply according to the type of assets or financial objectives.
What is the Straight Line and Written Down Method?
There are two methods of calculating depreciation. These are the straight-line method and written down value. Although each of these methods distributes the cost incurred on an asset over time, it is done differently.
Straight Line Method (SLM)
In the SLM, the depreciation amount is presumed to be uniform per annum from the date of inception of the asset till the date of its useful life. This method assumes that the asset depreciates its value uniformly over the years. Such a method is very simple and gets very often used especially on assets that give constant and consistent benefits with time, such as buildings or furniture.
Formula for SLM:
Written Down Value (WDV) Method
The WDV method calculates depreciation as a percentage of the asset’s book value at the beginning of every year. Here it is assumed that an asset depreciates more in the initial years of its life and less as time passes on. It is best suited for machinery or equipment that undergoes tremendous wear and tear in the initial years.
Formula for WDV:
The key difference between SLM and WDV lies in how depreciation is calculated and applied over time. While SLM charges a constant depreciation amount, WDV results in decreasing depreciation amounts over the asset’s life.
Methods of Calculation of Depreciation
There are several methods of calculating depreciation, each serving different purposes and reflecting how an asset’s value declines over time. The two main methods used are:
Straight Line Method (SLM)
This method allocates an equal amount of depreciation each year. It is simple to calculate and best suited for assets that provide uniform utility throughout their useful life.
Example:
If an asset costs $10,000, has a useful life of 5 years, and a residual value of $1,000, the annual depreciation will be:
Written Down Value (WDV) Method
The WDV method applies a fixed percentage of depreciation on the asset’s book value at the start of each year. This method results in higher depreciation in the early years and lower depreciation in later years.
Example:
If an asset costs $10,000, and the depreciation rate is 20%, the depreciation for the first year will be:
In the second year, the book value is now $8,000, so depreciation will be:
Both methods aim to allocate the cost of the asset over its useful life, but the **method of calculation** differs based on the assumptions about how the asset loses value over time.
Advantages of the Straight Line Method
The Straight Line Method (SLM) is often chosen for its simplicity and consistency in depreciation allocation. Some of the key advantages of the Straight Line Method include:
- Simple Calculation: SLM is straightforward to compute as it involves dividing the cost of the asset by its useful life. This ease of calculation makes it popular among small businesses and for assets that provide uniform benefits over time.
- Uniform Expense Allocation: Since the same amount of depreciation is charged each year, it provides a clear and consistent depreciation expense on the income statement. This consistency helps in budgeting and financial planning.
- Ideal for Long-Term Assets: SLM is well-suited for assets that have a long useful life and provide benefits equally over time, such as buildings, office furniture, or intangible assets like patents.
- Accurate Reflection of Asset Usage: For assets that degrade at a steady rate, the SLM provides an accurate reflection of the asset’s decline in value, matching depreciation expense with the revenue generated by the asset.
- Easy Comparability: The SLM makes it easy to compare the depreciation expense of similar assets across different periods, as the expense remains consistent year-over-year.
Advantages of the Written Down Method
The Written Down Value (WDV) Method is favored for assets that experience higher wear and tear in their early years. Some key advantages of the Written Down Method include:
- Higher Depreciation in Early Years: The WDV method accounts for the higher loss of value that many assets experience in the initial years of their use. This is especially true for machinery, vehicles, or technological equipment that loses efficiency over time.
- Tax Benefits: Since WDV results in higher depreciation in the early years, it reduces taxable income in those years. This can be advantageous for businesses looking to defer tax payments and reinvest in growth during the early stages of an asset’s use.
- Better Matching of Costs to Revenue: For businesses where assets generate more revenue in the earlier years, WDV ensures that depreciation is more closely aligned with the higher revenue, providing a more accurate representation of profitability.
- Reflects Actual Asset Usage: Many assets lose their productive value more quickly in the first few years. The WDV method more accurately reflects the actual usage and decline of the asset over time.
- Applicable for Shorter-Life Assets: The WDV method is ideal for assets with a shorter useful life or those that are subject to rapid technological obsolescence, such as computers, machinery, or vehicles.
Which Depreciation Method is Best?
The decision on the best method of depreciation to be used is based on the type of asset, pattern of revenue generation, and financial goals of the business. Each has its merits, but the correct method will depend upon the kind of business specified.
Straight Line Method (SLM)
SLM is best used on assets that provide constant value and utility in the long term. It is particularly effective for long-duration assets like buildings, furniture, and intangible assets. It provides a smoothed expense on the amortized depreciation, thus providing manageability and predictability of performance.
Written Down Value (WDV) Method
WDV is optimum for assets that depreciate early in their lives, like machinery or equipment or vehicles. It provides maximum tax advantage during the initial years of an asset’s usage and can also be used if a firm wants to make savings on taxes while also deploying those capital amounts back into the business.
Most businesses use WDV for assets with high initial periods of utilization, and SLM for assets utilized over longer periods. Such a choice is based on how the company would want to earn revenue and how it would like to control its reporting and taxation of transactions.
Conclusion
In conclusion, it follows that the distinction between SLM and WDV is in the method through which depreciation is computed and also an assumption about how assets depreciate over time. This means that the Straight Line Method deals with equal yearly provisions of depreciation which makes it very appropriate for assets of constant value. On the other hand, the Written Down Value Method attracts a higher depreciation rate in the early years. It may apply to those assets that exhibit rapid productivity or value decline in their early years. The application of these methods would instead depend on which type of asset is concerned, whether tax considerations or what financial policy to follow in running the business enterprise.
Difference Between SLM and WDV FAQs
What is the primary difference between SLM and WDV?
The main difference is, that SLM will charge a constant amount as depreciation every year, while WDV charges high depreciation initially and then tapers off.
Which has tax benefits?
The WDV method is more tax-favorable since it expels more depreciation during the early years that greatly reduce taxable income in those periods.
Can the two methods be applied to the same business?
Yes. A company can apply the two methods on different assets. It depends on the nature and use of the asset.
What is the formula for calculation of depreciation in the SLM method?
Cost of the asset minus residual value divided by the useful life is the SLM method for calculation of depreciation.
Is WDV applicable to all types of assets?
No, WDV is better suited for those assets which incur quick wear and tear in the early years, such as machinery and vehicles.
