How to Calculate Depreciation?

To calculate depreciation, subtract the asset’s residual or salvage value from the purchase costs then divide the remaining amount by the useful life. 

Cost of asset $15000
Expected residual or salvage value-$0
Depreciation Cost (the amount to be depreciated over the estimated useful life)$15000
Years of estimated useful life 05
Depreciation expense per year#3000

There are three main elements that you should take into account in this calculation:

  • The purchase costs of the business asset: Naturally, the purchase costs consist of the amount you paid for the product.
  • The lifespan: The life of the assets is the length of time the company expects to use these assets. So this is the time over which the assets are being depreciated.
  • Possibly a residual value: The residual value of the assets is the value for which a company is supposed to sell the assets if it has written it off.

Calculation example, If you buy a machine for $5,000, it will last 5 years and you can get $1,200 for it after those 5 years, the annual depreciation will be: ($5,000 – $1,200) / 05 = $760.

You can choose how to process the depreciation in the accounts. You can do this annually, but also quarterly or monthly. 

Invoice Quickly has a strong preference for monthly. This is the only way to have good judgment in the results of your company every month.

In this article we try to cover the following:

What has accumulated depreciation?

What is the difference between Depreciation and Accumulated Depreciation?

What are different methods of depreciation?

Four Main Methods of Calculating Depreciation

What is the impact of the depreciation method on the financial result?

Does the depreciation method affect your income taxes?

What Is Accumulated Depreciation?

The accumulated depreciation is the gross amount of depreciation expense allocated to a specific asset since it was started using. 

Almost all assets tend to lose value over time. Therefore, it is this loss that is represented by the accumulated depreciation. 

Example: 

Let’s assume a company purchased machinery on January 1, 2011, for $50,000. The machinery has a residual value of $15,000 and has an expected useful life of 7 years. On December 31, 2013, what is the balance of the accumulated depreciation account?

($50,000 – $15,000) / 7 = $5,000 in depreciation expense per year

Accumulated Depreciation
December 31st 2011$5,000
December 31st 2012$5,000
December 31st 2013$5,000
Ending balance$15,000
Asset
Machinery$50,000
Accumulated Depreciation-$15,000
Net Asset Value$35,000

What is the difference between Depreciation and Accumulated Depreciation? 

While both are related to reducing the value of the asset, there are differences between them. 

Depreciation Accumulated depreciation 
is recorded as an expense in the income statementis recorded in the balance sheet.
is a decrease in the value of the asset for the current periodis recorded up to that time
For example, $200 depreciation for each year, but accumulated depreciation for the second year was $400 and $600 for the second year and so on).

What are different methods of depreciation?

There are various depreciation methods. Among these, two methods are frequently used. These methods are;

  • Normal depreciation method
  • Decreasing balance method

Normal Depreciation Method

There are two methods to calculate the depreciation price directly and find the depreciation rate. If the depreciation fee is desired to be found directly, the tangible fixed asset’s economic life is divided. The result gives the annual depreciation fee.

For example, the cost of machinery is $3,000, and its economic life is three years.

Depreciation Amount = 3000/3 = $1.000 is determined.

Apart from this, if the depreciation rate is desired, a 1 / financial life ratio is derived over the tangible fixed asset’s economic life. This resulting ratio is divided by the cost of the asset.

For example, the tangible fixed asset cost is $5000, and its economic life is five years.

The depreciation rate = 1/5 = 0.2 = 20%.

Depreciation amount = 5,000 x (20%) = $ 1.000

Decreasing Balances Method

The netbook value per year is taken as a basis, not the purchase price of the asset. It is eliminated two times faster than normal depreciation. The removal rate decreases annually. It is possible to switch from the normal depreciation to the declining balances method. Still, if the declining balances method is started, it cannot be switched to the normal depreciation method.

To give an example of depreciation calculation with decreasing balance method, let’s say the purchase price of an asset is $2000, and its life is ten years;

For the year: 2000/10 × 2 = $400

For the year: (2000 – 80) / 5 × 2 = $768.

In addition to the traditional methods of making depreciation calculations, you can use the software and make transactions without errors and save much more time.

Four Main Methods of Calculating Depreciation

There are four main methods to calculate the depreciation of assets:

  • The straight-line depreciation rate. 
  • The declining balance method, 
  • The sum of the year’s methods.
  • Units of Production Depreciation

But according to the IRS, measuring monthly accumulated depreciation for an asset depends on the profitable lifespan of the asset. The productive or profitable lifespan of the asset range from 3 to 20 years for private property. 15 to 20 years for land progress, for real estate 27.5 years, and for business real estate 39 years. The IRS facts about the depreciation and lifetime of assets.

The Straight-line Depreciation

The straight-line depreciation method is the easiest to calculate, and the annual depreciation amount = (original net value of assets-estimated residual value) / service life.

Example: The original price of the machinery is $5,000, the estimated useful life is 10 years, the estimated residual value is $500, and the depreciation is calculated according to the straight-line method. 

The annual depreciation amount = ($5,000-$500)/10=450

If there is no residual value at the end of the time, the full amount will be accrued, and the annual depreciation = $5,000/10 =$500

The sum of years method and the double-declining balance method are both methods of accelerated depreciation. Accelerated depreciation means that more depreciation is drawn in the early stage of asset use, and less is drawn later so that the asset’s net value is compensated as soon as possible within the service life.

DECLINING BALANCE METHOD

The declining balance method is a quick depreciation method of recording larger depreciation expenses during the earlier years of an asset’s useful life and recording smaller depreciation expenses during the asset’s later years.

For example, if the machinery cost is $1,000, with a salvage value of $100 and a 10-year life depreciates at 30% each year, then the expense is $270 in the first year, $189 in the second year, $132 in the third year, and so on.

Sum of years method

It is a method to determine the depreciation amount of assets by multiplying the net value of the original value of the assets minus the residual value by a fraction that decreases year by year. The numerator with decreasing fractions year by year represents the number of years that the assets can still be used; the denominator represents the sum of the years of use years. 

Formula: Annual depreciation rate = total useful life/total estimated useful life

For example, The original price of an asset is $5,000, the estimated useful life is 5 years, and the estimated net residual value is $100. Depreciation is calculated according to the sum of years method. How to calculate the annual depreciation amount:

Total estimated service life = 5+4+3+2+1=15

The first year: Depreciation rate=5/15, Depreciation=(5000-100)*5/15=163.333

Second year: Depreciation rate = 4/15, depreciation = (5000-100) * 4/15 = 1306.66

The third year: Depreciation rate = 3/15, Depreciation = (5000-100) *3/15=980

The fourth year: Depreciation rate = 2/15, depreciation = (5000-100) *2/15=653.33

The fifth year: Depreciation rate = 1/15, Depreciation = (5000-100) *1/15=326.66

Accumulated depreciation over five years=163.333+1306.66+980+653.33+326.66=3429.98

Production units method

In the production unit method, the value of the asset is divided by the number of units it can produce during its entire useful life. In each period, the number of units produced in the period is multiplied by the depreciation cost corresponding to each unit.

Example:

If the machine valued is $10,000 that can produce 500 units throughout its useful life.

So 10,000 / 500 = 20. This means that each unit that is produced is charged a depreciation cost of $20

If in the first period, the units produced by the machine were 100 units, we have that the depreciation for the first period is: 100 x 200 = 200,00, and so with each period.

What is the impact of the depreciation method on the financial result?

Depending on the depreciation method chosen, the enterprise may obtain different financial results in individual write-off years, which is why each time, the selection of the depreciation method should be preceded by a thorough analysis and an attempt to forecast the company’s situation in the future. It is also worth considering non-financial factors.

Does the depreciation method affect your income taxes?

The selection of the depreciation method is certainly affecting one another. The cost of depreciation is one component of a deduction from income and income subject to tax. The total cost of depreciation is produced each year is very influential on profits and income taxes payable.

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