Composite depreciation is the application of a single straight-line depreciation rate and average useful life to the calculation of depreciation for a group of disparate fixed assets. The method is used to calculate depreciation for an entire asset class, such as office equipment or production equipment. Composite depreciation can also be used when there are a number of assets comprising a single larger asset; for example, the roof, air conditioning unit, and frame of a building may all have different useful lives, but can be aggregated for depreciation through the composite method. Another situation where composite depreciation can be used is for the depreciation of all the assets in an entire facility.
The depreciation steps are:
- Aggregate the total depreciable cost of all assets in the group.
- Assign a single useful life to the asset group.
- Divide the useful life figure by the total depreciable cost to arrive at the total depreciation per year under the straight-line method.
- Record the depreciation for the entire asset group.
In short, composite depreciation involves the use of a weighted average of the depreciation rates for all of the fixed assets in a group.
If an asset that is being accounted for under this system is sold, the related accounting entry is a debit to cash for the amount received and a credit to the fixed asset account for the historical cost of the asset. If there is a difference between the two, record it against the accumulated depreciation account. This accounting treatment means that no gain or loss is recognized at the point of asset sale or disposal.
Given the ease with which fixed asset accounting software can track the depreciation for individual assets, it is not really necessary to use composite depreciation, which may explain its rare usage. The system may have had greater applicability when manual record keeping was needed for fixed assets. Even then, the use of a high capitalization limit would prevent numerous assets from being recognized as fixed assets, thereby reducing the amount of manual accounting labor.
A possible use for composite depreciation is when an acquirer is processing the fixed asset records for an acquiree, and wants to create a depreciation calculation for a large number of assets with a minimal amount of effort.
The method can result in the recognition of a depreciation amount that differs markedly from the amount that would be recognized if depreciation were separately calculated for each individual asset. This disparity can arise when the useful lives of the assets in a group are substantially different from each other.