The Composite Depreciation Method is used for a collection of assets that are not similar in nature and have different useful or service lives. Under this method, different types of assets are combined into a single asset group and depreciation is calculated for the entire collection.
For example, computers and printers are different types of assets, but both may form part of office equipment. Since these assets are not similar and may have different service lives, they may be depreciated collectively under the Composite Depreciation Method.
Under this method, depreciation on the assets is determined by using the Straight Line Depreciation Method.
Basic Principle of Composite Depreciation Method
The Composite Depreciation Method combines different assets having different useful lives into one collection for depreciation purposes.
Instead of calculating and accounting for depreciation separately for each asset, the depreciation amounts of the individual assets are combined to determine the total annual depreciation of the collection.
A composite useful life and a composite depreciation rate are then determined for the entire group of assets.
Therefore, the method treats a collection of dissimilar assets as a combined unit for depreciation purposes.
Example of Composite Depreciation Method
Suppose office equipment consists of computers and printers. Computers and printers are not similar assets and have different service lives.
The depreciation details are as follows:
| Asset | Historical Cost | Salvage Value | Depreciable Cost | Useful Life | Depreciation per Year |
|---|---|---|---|---|---|
| Computers | $5,500 | $500 | $5,000 | 5 years | $1,000 |
| Printers | $1,000 | $100 | $900 | 3 years | $300 |
| Total | $6,500 | $600 | $5,900 | 4.5 years | $1,300 |
The total historical cost of the assets is $6,500, while the total salvage value is $600.
Therefore, the total depreciable cost is:
$6,500 − $600 = $5,900
The total annual depreciation calculated under the Straight Line Method is $1,300.
Calculation of Depreciable Cost
The depreciable cost of each asset is calculated by deducting its salvage value from its historical cost.
The formula is:
Depreciable Cost = Historical Cost − Salvage Value
For computers:
$5,500 − $500 = $5,000
For printers:
$1,000 − $100 = $900
Therefore, the total depreciable cost is:
$5,000 + $900 = $5,900
The total depreciable cost is used for calculating the composite life of the assets.
Composite Life
The Composite Life represents the average service life of the entire collection of assets for depreciation purposes.
The composite life is calculated by dividing the total depreciable cost by the total annual depreciation.
The formula is:
Composite Life = Total Depreciable Cost ÷ Total Depreciation per Year
In the given example:
Composite Life = $5,900 ÷ $1,300 = 4.5 years
Therefore, the composite life of the collection of computers and printers is approximately 4.5 years.
Although the computers have a useful life of five years and the printers have a useful life of three years, the combined composite life is 4.5 years.
Composite Depreciation Rate
The Composite Depreciation Rate is the depreciation rate applied to the total historical cost of the collection of assets.
The composite depreciation rate is calculated by dividing the total annual depreciation by the total historical cost of the assets.
The formula is:
Composite Depreciation Rate = Total Depreciation per Year ÷ Total Historical Cost
In the given example:
$1,300 ÷ $6,500 = 0.20 or 20%
Therefore, the composite depreciation rate is 20%.
This rate is applied to the total historical cost or balance of the asset account.
Calculation of Depreciation Expense
The annual depreciation expense is calculated by multiplying the composite depreciation rate by the balance in the asset account at historical cost.
The formula is:
Depreciation Expense = Composite Depreciation Rate × Total Historical Cost
In the given example:
20% × $6,500 = $1,300
Therefore, the annual depreciation expense is $1,300.
The depreciation expense calculated using the composite depreciation rate is equal to the total annual depreciation of the individual assets.
Accounting Entry for Depreciation
The depreciation expense calculated under the Composite Depreciation Method is recorded by debiting Depreciation Expense and crediting Accumulated Depreciation.
The accounting entry is:
Depreciation Expense A/c Dr. $1,300
To Accumulated Depreciation A/c $1,300
Depreciation Expense is charged to the Income Statement, while Accumulated Depreciation is used to reduce the carrying amount of the collection of fixed assets in the Balance Sheet.
Sale of an Asset under Composite Method
When an individual asset included in the composite group is sold, the cash received is debited and the asset account is credited with the original cost of the asset.
The difference between the original cost of the asset and the cash received is debited to Accumulated Depreciation.
The general accounting treatment is:
Cash/Bank A/c Dr.
Accumulated Depreciation A/c Dr.
To Asset A/c
The Asset Account is credited with the original cost of the asset sold.
No Gain or Loss on Sale of Asset
An important feature of the Composite Depreciation Method is that no gain or loss is recognised on the sale of an individual asset included in the composite group.
The difference between the amount received and the original cost of the asset is adjusted against Accumulated Depreciation.
The theoretical reason is that gains and losses arising from assets sold before and after the composite life are expected to average themselves out over the entire collection of assets.
Therefore, individual gains and losses are not separately recognised when assets are disposed of under the Composite Depreciation Method.
Difference between Group and Composite Depreciation Methods
The Group Depreciation Method is used for assets that are similar in nature and have approximately the same useful lives.
The Composite Depreciation Method is used for assets that are not similar in nature and have different service lives.
For example, a collection of similar assets having approximately equal useful lives may be depreciated under the Group Method. In contrast, computers and printers are different assets with different useful lives but may be combined as office equipment under the Composite Method.
Thus, the nature and useful lives of assets are the main basis for distinguishing between Group and Composite Depreciation.
Exam Focus
The Composite Depreciation Method is applied to a collection of assets that are not similar and have different service lives.
Under this method, depreciation on all assets is determined using the Straight Line Depreciation Method.
The main formulas are:
Composite Life = Total Depreciable Cost ÷ Total Depreciation per Year
Composite Depreciation Rate = Total Depreciation per Year ÷ Total Historical Cost
Depreciation Expense = Composite Depreciation Rate × Total Historical Cost
In the given example, the total historical cost is $6,500, total depreciable cost is $5,900, and total annual depreciation is $1,300. Therefore, the composite life is 4.5 years and the composite depreciation rate is 20%.
An important exam point is that no gain or loss is recognised on the sale of an individual asset under the Composite Depreciation Method. The difference is adjusted against accumulated depreciation because gains and losses on different assets are expected to average themselves out.
Remember the basic distinction: Group Depreciation is for similar assets with approximately similar useful lives, while Composite Depreciation is for dissimilar assets with different service lives.