How to Calculate Depreciation?
The value of a business asset over its useful life is known as depreciation.
Here’s the information you need to calculate depreciation:
- Useful life of the asset: This information is available in tables, based on the type of asset. You will probably need an accountant to tell you the useful life of a specific asset.
- Minus the salvage value: of the asset at the end of its useful life. Like the useful life, the salvage value is determined by a table.
- Divided by the cost of the asset: this includes all costs for acquiring the asset, like transportation, set-up, and training.
This will result in the book value of the asset.
For example, the annual depreciation on an equipment with a useful life of 20 years, a salvage value of $2000 and a cost of $100,000 is $4,900 (($100,000-$2,000)/20).
The asset must be placed in service (set up and used) in the first year that depreciation is calculated, for accounting and tax purposes.
For assets purchased in the middle of the year, the annual depreciation expense is divided by the number of months in that year since the purchase.
This article will also discuss:
What Is Accumulated Depreciation?
The cumulative depreciation of an asset up to a single point in its life is called accumulated depreciation. The carrying value of an asset on a balance sheet is the difference between its purchase price and accumulated depreciation. A business buys and holds an asset on the balance sheet until the salvage value matches the carrying value.
Accumulated depreciation is applicable to assets that are capitalized. Capitalized assets are assets that provide value for more than one year. Accounting rules dictate that expenses and sales are matched in the period in which they are incurred. Depreciation is a solution for this matching problem for capitalized assets. A portion of the cost of the asset in the year it is purchased and for the rest of the asset’s useful life is considered a depreciation expense.
Accumulated depreciation is the total amount that the asset has been depreciated over the asset’s life.
Three Main Methods of Calculating Depreciation
Depreciation can be calculated on a monthly basis in two different ways.
Determining monthly accumulated depreciation for an asset depends on the asset’s useful lifespan as defined by the IRS, as well as which accounting method you use.
The useful lifespan of an asset can range from three to 20 years for personal property, 15 to 20 years for land improvements, and are fixed at 27.5 years for residential real estate and 39 years for business real estate. The IRS has information about the depreciation and lifespan of assets.
The IRS currently uses the Modified Accelerated Cost Recovery System (MARCS) is the depreciation system that allows depreciation to be calculated by either the straight-line method or the declining balance method.
To do the straight-line method, you choose to depreciate your property at an equal amount for each year over its useful lifespan.
Use the following steps to calculate monthly straight-line depreciation:
- Subtract the asset’s salvage value from its cost to determine the amount that can be depreciated
- Divide this amount by the number of years in the asset’s useful lifespan
- Divide by 12 to tell you the monthly depreciation for the asset
Declining Balance Method
This method is used to recognize the majority of an asset’s depreciation early in its lifespan. There are two variations of this: the double-declining balance method and the 150% declining balance method.
The depreciation amount changes from year to year using either of these methods, so it more complicated to calculate than the straight-line method.
For the double declining balance method, the following formula is used to calculate each year’s depreciation amount:
To convert this from annual to monthly depreciation, divide this result by 12.
Sum-of-the-years’-digits (SYD) Method
The method that takes an asset’s expected life and adds together the digits for each year is known as the sum-of-the-years’-digits (SYD) method. This is an accelerated method to calculate depreciation.
So, if the asset is expected to last for five years, the sum of the years’ digits would be calculated by adding 5 + 4 + 3 + 2 + 1 to get the total of 15. Each digit is then divided by this sum to determine the percentage by which the asset should be depreciated each year, starting with the highest number in year 1.
The formula to calculate depreciation with the SYD method is as follows: