How to Figure Depreciation
Depreciation expresses loss of value over time of fixed assets in a business. It is a fundamental concept of business accounting. Depreciation is recorded as an expense on the books. Figuring depreciation takes into account the number of years a piece of equipment, for example, is expected to be in use for business purposes. Assets can suffer a decline in value due to wear and tear, damage, deterioration or obsolescence, among other factors. This article discusses the straight-line and declining-balance methods of calculating depreciation.
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Instructions
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Straight-Line Method
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Find out how much the asset cost. If you do not know, your purchasing, accounting or operations departments should be able to help.
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Find out the expected useful life of the asset. This is the number of years the asset will be in use. You should be able to get this information from the accounting or operations department.
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Figure the annual depreciation. The straight-line depreciation formula is as follows: Cost of the asset divided by the number of years of its useful life. For example, if your asset cost $25,000 and its expected use is 5 years, you would calculate $25,000/5 = $5,000. The asset is expected to lose $5,000 in value each year. At the end of the 5-year period, its book value will be zero.
Declining-Balance Method
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Find out the cost of the asset.
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Find out its useful life. Ask your accounting or operations department for the data.
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Figure the rate of annual decline in value. The declining-balance method formula is stated as follows: 100 percent divided by the number of years of useful life, then multiplied by 2, i.e., (100% / x) X 2, where x is the number of years of useful life. Assuming the asset cost $25,000 and its useful life is 5 years, figure as follows: (100% / 5) X 2 = 40%.
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Apply this rate to the remaining asset value each year. For example, if your asset cost $25,000, you would multiply $25,000 by 40 percent to get $10,000. After one year of use, the value of the asset will be reduced by $10,000 ($25,000 - $10,000 = $15,000). The second year, you would apply the rate of decline to $15,000, the remaining balance: $15,000 X 40% = $6,000. Then you would deduct $6,000 from $15,000: $15,000 - $6,000 = $9,000. The third year, calculate the rate of decline by multiplying $9,000 by 40 percent, which comes to $3,600. Deduct $3,600 from $9,000 to arrive at the depreciation amount for that year: $9,000 - $3,600 = $5,400. Continue this calculation for the duration of the asset's useful life.
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Tips & Warnings
Other methods of calculating depreciation exist. See accountingcoach.com to learn more.
It may be useful to figure monthly depreciation for some assets. Once you have calculated the annual depreciation, simply divide the figure by 12.
Depreciation must be calculated in accordance with existing tax law. Be sure you and your accountant are aware of relevant changes to the tax code.
