# Topic No 704, Depreciation Internal Revenue Service

This also allows for measuring cash flows generated from the asset in relation to the value of the asset itself. The depreciable cost is the cost of an asset that can be depreciated over time. It is equal to acquisition cost of the asset, minus its estimated salvage value at the end of its useful life. The examples below demonstrate how the formula for each depreciation method would work and how the company would benefit.

Different methods of asset depreciation are used to more accurately reflect the depreciation and current value of an asset. A company may elect to use one depreciation method over another in order to gain tax or cash flow advantages. With the straight line depreciation method, the value of an asset is reduced uniformly over each period until it reaches its salvage value. Straight line depreciation is the most commonly used and straightforward depreciation method for allocating the cost of a capital asset. It is calculated by simply dividing the cost of an asset, less its salvage value, by the useful life of the asset. The total amount depreciated each year, which is represented as a percentage, is called the depreciation rate.

## What Is Depreciation, and How Is It Calculated?

Thus, the depreciated cost decreases faster at first and slows down later. The double declining-balance depreciation is a commonly used type of declining-balance method. If the machine’s life expectancy is 20 years and its salvage value is \$15,000, in the straight-line depreciation method, the depreciation expense is \$4,750 [(\$110,000 – \$15,000) / 20]. Thus, the amount of depreciation is calculated by simply dividing the difference of original cost or book value of the fixed asset and the salvage value by useful life of the asset. As such, the company’s accountant does not have to expense the entire \$50,000 in year one, even though the company paid out that amount in cash. The company expenses another \$4,000 next year and another \$4,000 the year after that, and so on until the asset reaches its \$10,000 salvage https://personal-accounting.org/returns-inwards-or-sales-returns-definition/ value in 10 years. The sum-of-the-years’ digits (SYD) method also allows for accelerated depreciation. The company decides on a salvage value of \$1,000 and a useful life of five years. Based on these assumptions, the depreciable amount is \$4,000 (\$5,000 cost – \$1,000 salvage value).

## How Do You Calculate Depreciation Annually?

The examples of depreciable assets include tangible assets such as equipment, machinery, building and furniture. Companies have several options for depreciating the value of assets over time, in accordance with GAAP. Most companies use a single depreciation methodology for all of their assets. Thus, the methods used in calculating depreciation are typically industry-specific. Depreciation is considered to be an expense for accounting purposes, as it results in a cost of doing business. As assets like machines are used, they experience wear and tear and decline in value over their useful lives.

• Harold Averkamp (CPA, MBA) has worked as a university accounting instructor, accountant, and consultant for more than 25 years.
• This formula is best for companies with assets that lose greater value in the early years and that want larger depreciation deductions sooner.
• For example, a manufacturing company purchased a machine at the beginning of 2017.
• Declining balance depreciation allows companies to take larger deductions during the earlier years of an assets lifespan.

This rate of depreciation is twice the rate charged under straight line method. Thus, this method leads to an over depreciated asset at the end of its useful life as compared to the anticipated salvage value. Under this method, an equal amount is charged for depreciation of every fixed asset in each of the accounting periods. This uniform amount is charged until the asset gets reduced to nil or its salvage value at the end of its estimated useful life. Double declining balance is the most widely used declining balance depreciation method, which has a depreciation rate that is twice the value of straight line depreciation for the first year. Use a depreciation factor of two when doing calculations for double declining balance depreciation.

## Depreciated Cost

For example, the company ABC has a delivery truck with the original cost of \$32,000 and an estimated salvage value of \$2,000. However, after 2 years of intensive use, the company ABC estimates that the truck will only last for 2 more years with the same salvage value of \$2,000. As per the sum of years’ depreciable cost formula formula, the depreciation for the machinery is \$540,000 in the first year and \$480,000 in the second year. In this method, we assign the item’s total loss of value over the time that we use it. This method gives more loss in the beginning and less loss later on, making it go down gradually. 