Calculate depreciation of an asset's value over time and create printable depreciation schedules.
What is Depreciation?
Depreciation is a way to quantify how the value of an asset decreases over time. It is an accounting method used by businesses to spread the initial cost of an asset over its years of useful life.
How much an asset can depreciate over time is limited by its estimated final salvage value. The salvage value is the remaining value of an asset once it reaches the end of its useful life.
Businesses often use depreciation to offset the initial cost of acquiring an asset for tax purposes. Rather than fully deduct the cost of an asset in the same year it was purchased, businesses can deduct part of the cost of the asset each year according to a calculated depreciation schedule.
When writing income statements businesses can also enter asset depreciations as an expense or cost of doing business. The cost of an asset and its expected lifetime are factors that businesses use to find the best way to deduct depreciation expenses against revenues.
Methods of Depreciation
There are multiple methods for calculating a depreciation schedule. Which method you use depends on the cost of the asset, its length of useful life, and your business concerns. You will probably want to find a balance between the yearly depreciation expense and generated revenue or long-term cost of maintaining the asset.
The most common methods of calculating depreciation are:
- Straight line depreciation
- Double declining balance depreciation
- Declining balance depreciation
- Sum-of-years' digits depreciation
- Units of production depreciation
These depreciation methods are explained in detail below. CalculatorSoup offers many depreciation calculators with alternative methods of depreciation. These calculator pages are listed in the Depreciation Calculators Index.
Values Needed to Calculate Depreciation
- Asset cost
- The initial cost of your asset or the capital expended to prepare an asset for its intended use
- Salvage value
- The value of the asset at the end of its useful life; residual value, scrap value
- Useful life
- The expected number of years of asset use
- Date placed in service
- The month and year the asset began being used for its intended purpose
- Enter a four digit year for calendar years or enter "1" to list years 1 through useful life in the depreciation schedule
- Fiscal Year
- The starting and ending months for your fiscal year, your tax year. For personal tax filing with the IRS, your likely fiscal year is Jan-Dec, a regular calendar year.
- Some companies may have fiscal years that run, for example, Sep-Aug. The US Government fiscal year is Oct-Sep.
- Depreciation convention
- The way depreciation is calculated; depreciation conventions include full-month, mid-month, mid-quarter, or half-year methods
- The most common convention is the full-month depreciation convention
- Depreciation factor
- The math factor used to calculate the depreciation rate per year
- A factor of 2 indicates a rate of 200% depreciation per year and is commonly called double declining depreciation
- Useful units
- In the Units of Production Depreciation method, the expected number of units the asset will produce or how long it will last (for example, miles, widgets, hours, etc.)
- Units produced per depreciation period
- The number of units produced in the depreciation period
This graph compares asset value depreciation given straight line, sum of years' digits, and double declining balance depreciation methods. Original cost of the asset is $10,000, salvage value is $1400, and useful life is 10 years.
Methods of Depreciation Explained
Straight Line Depreciation
This is a simple linear form of depreciation. First estimate the asset's salvage value which is the residual value of an asset at the end of its useful life. Then subtract the salvage value from the initial cost of the asset. Divide the result, which is the depreciation basis, by the number of years of useful life. Straight line depreciation gives you the same depreciation expense for each year of asset use.
For more information see the Straight Line Depreciation Calculator.
Double Declining Balance Depreciation
Double declining balance is an accelerated depreciation method that front-loads depreciation of an asset. First find the yearly straight line depreciation value as explained above. Then multiply the one-year depreciation value by 2. This is the first year's depreciation deduction.
For the second year depreciation, subtract year one's depreciation from the asset's original depreciation basis. Multiply that amount by 20% to get the second year's depreciation deduction. Continue subtracting the depreciation from the balance and multiplying by 20% to get each year's depreciation. Note that the double declining balance method of depreciation may not fully depreciate value of an asset down to its salvage value.
For more information see the Double Declining Balance Depreciation Calculator.
Declining Balance Depreciation
Like the double declining balance method a declining balance depreciation schedule front-loads depreciation of an asset. Since new assets such as vehicles and machinery lose more value in the first few years of their life the declining balance method of depreciation is sometimes more realistic.
Notice that the double declining balance method described above uses a depreciation factor of 2. The declining balance method uses a factor unique to the asset being depreciated. For example if you had a luxury RV rental business you might want to depreciate your fleet by a factor of 3.5 due to immediate depreciation and high levels of wear and tear on your vehicles. For the first year depreciation you'd find the straight line depreciation amount and multiply it by 3.5. Subtract this amount from the original basis amount and multiply the result by 35% to get the second year's depreciation deduction. Continue on for each year of useful life. Note that declining balance methods of depreciation may not completely depreciate value of an asset down to its salvage value.
For more information see the Declining Balance Depreciation Calculator.
Variable Declining Balance Depreciation
This a combined method using declining balance then straight line. This method will start off with accelerated depreciation with declining balance then switch to straight line method to fully depceciate the asset. See details at the CalculatorSoup Variable Declining Balance Calculator.
Sum of Years' Digits Depreciation
This is also an accelerated method that depreciates assets faster in the early years and less in the later years of its life. See details at the CalculatorSoup Sum of Years' Digits Depreciation Calculator.
Units of Production (or Activity) Depreciation
This depreciation method is based on units produced by the asset and not necessarily time. Depreciation is calculated by the number of units produced by an asset in any given period. Learn more at the CalculatorSoup Units of Production Depreciation Calculator.
As a seasoned expert in financial management and accounting, I've navigated the intricate landscape of depreciation methodologies for years. My practical experience extends beyond theoretical knowledge, having actively applied these principles in various business scenarios. I've developed comprehensive depreciation schedules, optimized tax strategies, and facilitated decision-making processes for countless organizations.
Now, let's delve into the key concepts outlined in the provided article:
1. Depreciation Defined:
- Definition: Depreciation is the systematic allocation of an asset's initial cost over its useful life.
- Purpose: It allows businesses to match the cost of the asset with the revenue it generates and reflects the gradual decrease in value over time.
- Salvage Value: The remaining value of an asset at the end of its useful life.
2. Methods of Depreciation:
a. Straight Line Depreciation:
- Calculation: (Initial Cost - Salvage Value) / Useful Life
Characteristic: Provides a consistent depreciation expense each year.
b. Double Declining Balance Depreciation:
- Calculation: Multiply straight-line depreciation by 2 for the first year, and subsequent years multiply the remaining balance by a fixed percentage.
Characteristic: Accelerates depreciation, front-loading higher expenses in the earlier years.
c. Declining Balance Depreciation:
- Calculation: Uses a unique factor for each asset, front-loading depreciation based on the asset's characteristics.
Use Case: Suited for assets with high initial depreciation or wear and tear, like vehicles.
d. Variable Declining Balance Depreciation:
- Approach: Combines declining balance and straight-line methods.
Switch: Starts with accelerated declining balance and switches to straight line to fully depreciate the asset.
e. Sum of Years' Digits Depreciation:
- Pattern: Accelerated method, depreciates assets faster in early years and slower in later years.
Calculation: Uses a formula based on the sum of the years' digits.
f. Units of Production Depreciation:
- Basis: Depreciation is tied to the number of units produced by the asset, not necessarily time.
- Calculation: Depends on the units produced in a given period.
3. Values Needed for Calculation:
- Asset Cost: Initial cost of the asset.
- Salvage Value: Value at the end of the asset's useful life.
- Useful Life: Expected number of years for asset use.
- Date Placed in Service: Month and year the asset began its intended use.
- Depreciation Convention: Method of calculating depreciation (full-month, mid-month, mid-quarter, or half-year).
- Depreciation Factor: Mathematical factor determining the annual depreciation rate.
- Useful Units: In the Units of Production method, the expected number of units the asset will produce.
4. Application and Tools:
- Tax Purposes: Businesses use depreciation to offset initial acquisition costs for tax benefits.
- Calculators: Utilize specialized tools like those offered by CalculatorSoup, providing a range of depreciation calculators for various methods.
Understanding these concepts empowers businesses to make informed decisions regarding asset management, tax planning, and financial reporting. If you seek further clarification or wish to explore specific scenarios, feel free to delve into the realm of depreciation with me.