Connect with us

Accounting

How To Calculate And Record Depreciation [of Fixed Asset]

Published

on

As a business uses its assets, the assets eventually get used up. Businesses track the use of their assets by calculating depreciation expenses. This post will introduce you to depreciation and the various methods that are used to calculate it. Through this post you can learn the very basic [and take practice] the various depreciation methods and learn how to track them within your bookkeeping system.

 
Understanding Depreciation

Advertisement

You probably think of depreciation as something that happens to a new car when you drive it off the lot after purchasing it. All of a sudden it is worth 20 to 30 percent less and it’s called depreciation. Well, for bookkeeping purposes it’s not quite the same thing. Accountants use depreciation to adjust the books based on the aging of a piece of equipment or other asset.

As an asset is used, its useful life is reduced. For example: when you drive a car 15,000 to 20,000 miles a year, you know that eventually it will need more and more repair until finally you decide it’s used up and you want to replace it with something new. That happens to manufacturing machineries and equipments, furniture and fixtures, as well as any other business asset held for more than a year. A company needs to track this use of assets to know the value of what it has and also to estimate repair and replacement costs based on the age of its assets.

Not everything can be depreciated. Any item that you expect to use up in a year is not eligible for depreciation. These types of items are written off as expenses instead. You also don’t depreciate land. Land does not get used up. While you cannot depreciate a building or car you rent or lease, if you do major renovations to a leased property you can depreciate the value of those improvements by capitalizing.

Assets you own that are used for both your business and your personal life can be partially depreciated based on percentage of use. The two most common types of partially depreciated assets for people who own a home business are their car and a portion of their house. For these situations the business owners are primarily looking to take advantage of the tax savings that can be generated by depreciation.

This post focuses on depreciation expenses. Depreciation for tax purposes is an entirely different topic. I will post it separately next time. So keep checking into this blog, or check with your accountant to find out more information about depreciation methods used for tax purposes or read IRS publication 946, “How to Depreciate Property” [www.irs.gov/publications/p946/index.html].

 

 

Figuring Out The Useful Life Of Fixed Asset

The first thing you must determine when you need to calculate the depreciation for an asset is how long that asset will be useful to the company. While you can set up your own table for periods of useful life for types of assets in your business, you will have to justify the lifespan you’ve chosen if it differs from IRS rules. So most businesses use the depreciation recovery periods set up by the IRS, which set an average useful life for business assets as shown below.

Depreciation Recovery Periods for Business Equipment

Property Class         Business Equipment
Recovery Period

3-year property             Tractor units and horses over two years old

5-year property             Cars, taxis, buses, trucks, computers,

                                     office machines (faxes, copiers, calculators,

                                     and so on), research equipment and cattle

7-year property             Office furniture and fixtures

10-year property           Water transportation equipment,

                                      single-purpose agricultural or
                                      horticultural structures, and fruit- or

                                      nut-bearing vines and trees.

15-year property           Land improvements, such as shrubbery,

                                      fences, roads, and bridges

 

Some types of business will use a different depreciation schedule. For example: a rental car business may shorten the useful life of a car from five years (as estimated by the IRS) to two years because its cars are used much more frequently and get used up much quicker than they would in another type of business.

 

Determining the Cost Basis Of Fixed Asset

The other key factor in calculating depreciation is the cost basis of an asset.

The equation for cost basis is:

= Cost of the fixed asset + Sales tax + Shipping and delivery costs + Installation charges + Other costs [such as commissions or finder’s fees]

Description:

  • Cost of the fixed asset; is what you paid for that equipment, furniture, building, vehicle, or any other asset you intend to use for more than 12 months
  • Sales tax; is the actual taxes you were charged when purchasing that asset.
  • Shipping and delivery; includes any charges that you paid to get that asset to your place of business.
  • Installation charges; include any charges you paid to get that asset working in your business. That could include new electrical outlets, carpentry work, or any type of work that was needed to install the new asset.
  • Other costs include any other costs involved in the purchase of the asset. This can include commissions or finder fees, as well as additional hardware such as wiring or monitors to put a new piece of equipment into operation.

 

Example: How to calculate the cost basis of a new desk for your office. You bought the desk for $1,500 and paid $90 in taxes. You paid $50 to have it delivered.

Here is how:

Cost basis = $1,500 + $90 + $50 =$1,640

 

Depreciation Methods That You Can Choose to Depreciate The Fixed Assets 

Once you know your assets anticipated life span and its cost basis, you can then calculate how much you should write off for depreciation. Depreciation is not a cash expense. The cash expense happens when you buy the asset or a cash inflow can happen when you sell the asset. Depreciation just shows the use of that asset, so it does not involve the use of cash. I am going to show you how to record depreciation in the boooks after this section.

You actually can choose from four different methods to calculate depreciation — Straight-Line, Sum-of-Years-Digits, Double Declining Balance, and Units of Production. I am going to show you how to calculate each below and then give you a chance to practice.

 

Straight-line Method

Straight-line depreciation spreads out the cost of the asset over the entire useful life of an asset. It’s the simplest type of depreciation to calculate.

The formula is:

Annual depreciation expense = [Cost of the asset – Salvage] / Estimated useful life

 

The salvage value is the value you expect the asset will have when you sell it after you have finished using it for your business. For example, if you buy a car for $25,000 and expect to be able to sell it for $5,000, the salvage value of that car would be $5,000.

Example: How to calculate the annual depreciation expense for a car with a cost basis of $25,000 and a $5,000 salvage value using the IRS recovery period?

Looking at the IRS chart you see that a car has a 5-year lifespan according to the IRS. So you would calculate straight-line depreciation in this way:

($35,000 – $5,000) = $30,000 $30,000/5 = $6,000 annual depreciation expense

Sum-of-years-digits [SYD]

Sometimes a business determines that an asset is used up more quickly in the early years, so it decides to use the sum-of-years-digits (SYD) method. This is common for a trucking company when it buys a new truck. The SYD calculation is a three step process:

Step-1. Find the SYD for the current fiscal year using this formula:

N(N + 1) / 2 = SYD (N would be the number of years of useful life).

Note: The SYD would be the same each year of calculation.

 

Step-2. Find the application fraction using this formula:

N/SYD (N would be the number of years remaining of useful life).

 

Step-3. Calculate the depreciation expense formula:

(Cost – Salvage value) × Applicable fraction = Depreciation expense.

 

Calculate the first year of the depreciation expense for a car that had a cost basis of $35,000 and a salvage value of $5,000 using the sum-of-years-digits depreciation method. Assume the IRS recovery period of 5 years.

The answer is:

SYD = 5 (5 + 1) / 2 = 30/2 = 15
Applicable fraction = 5/15 = 1/3
Depreciation expense = ($35,000 – 5,000) × 1/3 = $30,000 × 1/3 = $10,000

 

Double-declining Balance Method [DB]

Sometimes businesses want to write off an asset even more quickly than they can use the SYD depreciation calculation because they believe the assets lose usefulness faster. In this case they use a method called double-declining balance, which is double the amount of depreciation allowed using straight-line depreciation. You must calculate a depreciation factor the first year you use double-declining depreciation by using this formula:

2 × [1/Estimated useful life] = Depreciation factor

 

You then multiply that factor by the book value at the beginning of each year. The depreciation factor will be the same for each year of the calculation. Salvage value should not be subtracted from the book value, but once the book value is equal to the salvage value, you can’t depreciate any more.
Example: How to calculate the first year of a car’s depreciation expense using the double-declining balance method?. The cost basis of the car is $35,000 with a salvage value of $5,000. Assume the IRS recovery period of 5 years

The calculation would be 2 × (1/5) = 0.40
Multiply it:  $35,000 × 0.40 = $14,000

 

 
Units of Production [UOP]

The units of production (UOP) method of deprecation is used primarily in a manufacturing environment and you would not likely need to calculate depreciation expenses manually in that type of environment. Most likely there would be a computer program for calculating depreciation, so I won’t set up a problem to practice this calculation.

In this case the number of units to be produced by the machinery is the key factor that a company wants to track rather than the useful life in years. Rather than calculating a depreciation factor you calculate a UOP rate and then the depreciation expense using this two step process:

To find the UOP rate, use this formula:

[Cost – Salvage value] / Estimated number of units to be produced during the estimated useful life
To find the depreciation expense, use this formula:

Units produced during the year × UOP rate = Depreciation expense

Companies who choose to use this method usually have a wide variation in production levels each year.

 

 
Setting Depreciation Schedules

Remembering how much to depreciate for each asset you have in your business can be an overwhelming task. The best way to keep track of what you need to expense each year is to set up a depreciation schedule for each type of asset that lists the date it was put into service, the description of the asset, the cost basis, the recovery period, and the annual depreciation. Below is a sample of this type of schedule:

Depreciation Schedule: Vehicles

Date Put in     Description     Cost         Recovery           Annual
Service                                   Period      Depreciation

1/5/2006        Black Car        $30,000    5 years              $5,000
1/1/2007        Blue Truck      $25,000    5 years             $4,000

 

 

Recording Depreciation Expenses

Recording depreciation expenses can be a simple entry into your accounting system. Most businesses do the entry at the end of a quarter or the end of the year when they close the books. After calculating depreciation expense, here is the type of entry you would use for a depreciation expense of $4,000 for a vehicle:

[Debit]. Depreciation Expense = $4,000
[Credit]. Accumulated Depreciation = $4,000

 

Depreciation expense is a line item on the Income Statement and Accumulated Depreciation is a line item on the Balance Sheet.

41 Comments

41 Comments

  1. Ray Mischkot

    Apr 16, 2009 at 9:47 pm

    Very useful explanation of depreciation and the difference between book and tax basis. I work in the power industry and have a question. Are you aware of the units of production method being used to deprciation power plants, especally unregulated plants that are regularly cycled?

  2. Kuriankoipuram

    Sep 14, 2009 at 2:30 pm

    could u b more elaborate on uop. be true, I was looking for these explnation. Thanku!!!!!!!!

  3. MannyK

    Sep 17, 2009 at 4:46 pm

    This was a super helpful explanation of depreciation, Thank You! I’m putting together projections for a new business and this was the clearest explanation I found.

    One Question though! Can you include engineering costs in the cost of an asset? For instance, if I pay an engineer $10,000 to engineer a piece of equipment that costs $25,000 to build, do I add the 10k to the cost of the equipment or do I expense the engineering cost as R&D?

    Thanks a million!

  4. Putra

    Sep 18, 2009 at 1:27 am

    MannyK,

    The decision whether to capitalize [add up] “related costs incurred subsequent installment” of machineries/equipments is kind of confusion, but there are some general rules to follow.

    Engineering/re-engineering cost in your case, ask yourself the following questions:

    [1]. Is the engineering cost can prolong economic lifetime of the machine? If yes, then you would capitalize it. Otherwise, you would not.

    [2]. Is the engineering cost increases capacity [speed or unit production output]? If yes, then capitalize it. Otherwise, don’t. Or; is by re-engineering the machine become a machine that able to produce a better quality [a more expensive] of products? If yes, then you would capitalize the engineering cost.

    [3]. Is amount of the engineering cost significant compare to the initial acquisition [purchase] cost? Yes. A $10K is a big value compare to the initial cost [$25K]. So, you should capitalize it. Let’s say the cost was only $100, that would not be significant, you wouldn’t capitalize it.

  5. Putra

    Sep 18, 2009 at 1:40 am

    To be clear; Any “related” costs incurred prior to installment, it is allowed to be included into the purchase [acquisition] cost.

    To prove whether the cost considered to e related or not. Ask a questions:

    Is without the engineering cost, the machine won’t be functioning as it is initiated? If the answer is “NO” then it has a positive relation. Otherwise it is questionable

    🙂

    • Mojani's

      Oct 31, 2011 at 4:31 pm

      This was a super helpful explanation of depreciation But I have a question for instance If a computer has original cost of $1000, a useful life of 5 years and a salvage value of $100.
      and I start to depreciate it . but Ihad sold it in the 3 year so how the depreciation is going to be ?? and also I would like to know how can we record it ???

  6. George

    Sep 18, 2009 at 4:14 pm

    Can i depreciate a new computer that i bought for my new bookkeeping business?

  7. Putra

    Sep 19, 2009 at 1:24 am

    George,

    Yes, you can start depreciating the new computer since the very first month of when the computer was occupied for the business.

    Eg: If you purchase the computer on September 01, you installed and start using the computer on Sept 02, then you may declare depreciation expense on your “September Income Statement [P&L]”.

  8. Victor Ong

    Sep 19, 2009 at 12:53 pm

    Hi Mr. Putra,
    Thank you very much for your unreserved sharing of so many informative articles on derivative accounting.
    I work for a futures broking firm. As a futures broking firm, we do not take position. Our clients’ spot FX positions (which are on margin) are all back-to-back with our Prime Brokerage Bank (PBB).
    Recently, I have a question which I was not able to resolve.
    It is with regard to a client transaction which my firm took delivery.
    May I know if I could have your email address so that I could write to you the details.
    My email is victor_ong_168@yahoo.com
    Many Thanks for your help.
    Victor Ong

  9. Victor Ong

    Sep 20, 2009 at 1:45 am

    Hi Mr. Putra,
    My email is victor_ong_168@yahoo.com.
    I look forward to hearing from you.
    Thanks a lot.
    Victor

  10. Putra

    Sep 20, 2009 at 4:06 am

    Hello Victor,

    I have submitted a blank e-mail so that you can contact me through e-mail as on demand.

  11. Victor

    Sep 21, 2009 at 7:48 am

    Hi Mr. Putra,
    I have emailed you my question.
    Many Thanks in advance for your kindness.
    Best Regards
    Victor

  12. Wina

    Dec 6, 2009 at 1:45 am

    Hi Mr. Putra,

    Is the depreciation schedule that you mention in the article above, the same with the IFRS standard?

    Thanks a lot.

    Best Regards,
    Wina

  13. Hi Putra

    Jan 13, 2010 at 4:34 pm

    Kindly provide me with your e-mail address. I have this concern that I will like to share with you.

    Thank you.

    Olamide.

  14. Jay

    Mar 23, 2010 at 4:46 pm

    If i acquire machine in March 1st 2008 for manufacturing purpose and i didnt use it for manufacturing in 2008,do i have to consider depreciation for 2008?

  15. lee

    Mar 29, 2010 at 4:35 am

    as what i have learned you need to capitalize any attributable cost that are used in putting up the machine/asset to its final condition, whether for use or for sale.

  16. Alina

    Apr 25, 2010 at 7:59 am

    HI,
    I just want to know what happens to a business car when its written off, and the insurance gives them a new car ? what happens to the depreciation of the old car?

  17. Sami

    May 17, 2010 at 6:16 am

    Hi,
    I need spread sheet of cost breakup proforma for an engineering company

    Thanks

  18. jhun

    May 28, 2010 at 6:38 am

    Hi Mr. Putra,

    Im jhun working in a car accessories, can i have your email address?

    thanks.

  19. edina

    Jun 8, 2010 at 6:36 pm

    Thanks maybe I didn’t do my budget right in the 1st place

  20. dave

    Feb 4, 2011 at 11:15 am

    hi,
    i am doing a research in agricultural economics and i am required to formulate an income statement for the farmers. Which is the most appropriate method to use as there are different kinds of equipment used by the farmers.
    The tools and equipment are : cutlass, hoe, knapsack sprayers,garden line,watering cans,pumping machine,harvesting sacks,land
    thx

  21. ARR

    Feb 13, 2011 at 1:19 am

    Hello:

    I’m starting a new company and I will use items that I have for some time as desks, chairs, printers, etc. What is the proper way to record such transactions, because even I have no receipts for purchases of these items. As I have to record these items and make the appropriate depreciation?

    Thanks again for your valuable help!

  22. Monica Ramos

    Mar 14, 2011 at 9:26 am

    Hi there, need some help calculating depreciation using straight line method for the following scenario:

    Defence Ministry transfers to a utility (newly established) the existing water works and distribution system (estimated residual life 10 years). These assets were built ten years ago at a current cost of 18 million USD. One third of the transfer represents a gift; the remainder is a long-term loan with a one year grace period.

    Any thoughts on what the depreciate value would be. I have come up with $900,000 using $18 million over 20 years, however, am not sure if that is correct and if the way that the asset has been transferred will affect the way that depreciation is calculated.

    Appreciate the help.

  23. ayesha

    Mar 17, 2011 at 10:12 am

    Hi Mr Putra,

    I have 9 years of administration experince and not much of Accounting.I have done MBA Marketing so understand and have studied Accounting.Kindly guide me what accounting experience do I need to add in my CV inorder to qualify as an Admin and Accounts Manager.I friend who will give me guidance and will teach me the stuff like spread sheets,bank reconciliations and budgeting for a company,account plan etc are they relevant and if seen in my CV I will qualify as an admin and account manager

  24. shaik

    Jun 7, 2011 at 6:31 am

    Hi Putra,

    Firstly ur explanation is truly impressive.

    As u shown about UOP, we are able to calculate rate of units by dividing cost with estimated produce of unit over period.

    i want to know how do we calculate rate of hours. we have some machines based on estimated use of hours of life. plz provide the method of calculating for hours. send me by email on this shaikmohammed81@yahoo.com

    thanks

  25. Mirza Faisal Baig

    Jul 10, 2012 at 9:53 am

    Hi, i am interested to know about complete cycle of budgeting & Paid-up capital accounting in book & balance sheet.

    Best Regards.

    Faisal Baig

  26. Jade B. Macapinig

    Jul 23, 2012 at 2:19 am

    Please provide me a formal format computation on fixed assets budget/forcast for 5 years. May I know how does it looks like and how it should be done?

    thank you for your support.

    may god bless you always.

  27. Shahpoor Fazily

    Jul 23, 2012 at 4:15 am

    Hi, found this post very useful.
    Thanks a million.

  28. Daniel Tekle

    Dec 9, 2012 at 9:18 pm

    Hi, i want guidance on how to calculate basic record, at least, one example about depreciation

    Thank you

    • TETAZ

      Nov 6, 2015 at 9:15 am

      How many accounts which are affected when calculating depreciation and which account is supposed to be debited and credited. What is the effect in the cash flow statement?

  29. Fredrik

    Feb 10, 2013 at 9:23 pm

    I’m a new hired as accountant in small company. I discovered they never depreciate their fix asset for 4 years already. Can I make an adjustment for the 4 years depreciation in 2012, or do I have to adjust their previous financial statement? and how to report the revised F/S for the IRS? Also, I found their accounts receivable never be updated with bad debts account, which some of their receivables is already become uncollected account. Could you please give me some advise?

  30. katlego

    Mar 15, 2015 at 10:35 am

    the balance of the cost price of office buildings is 200 000 on 1 march 2011. depreciation is 5% on the reducing balance method, the accounting year end is on 28 February .how do we calculate depreciation and the carrying value at the beginning of the year

  31. Mohammed

    Jul 13, 2015 at 8:52 am

    Quick Questions:

    1-Your facility’s heating and cooling system is 18 years old. Maintenance for it has become frequent and costly. It was the best system available when purchased and has ample capacity but repairs are expensive. A new system would require significant capital dollars and there are several alternatives with varying service lives. How would you assess your economic alternatives?

    2-Your capital equipment is depreciated over five years. How should you account for this during the FM budgeting process?

    Thanks for your advice

  32. Darlene Clark

    Oct 2, 2015 at 4:50 pm

    I am the administrator at my church and I have been asked to prepare a list and estimated value for all of the electronic equipment that the church owns. I do not handle or pay for many of the purchases (they are handled by our treasurer who resides in another state) so I am trying to collect information on the receipts and invoices for the purchases which have occurred over the course of six years so that I can get an idea of what I’m working with. I need advice on how to depreciate the value of the equipment.

    The types of equipment are: sound and video mixer boards, computers, video cameras, projectors, speakers and monitors, drums, wireless and corded microphones, cable snakes, CD and DVD disc recorders and players, spot lights, tripods, television monitors, and musical instruments, etc. I would like to know how to determine an estimated value for this equipment.

    I appreciate any assistance that you can offer in this quest. Thank you very much.

  33. Manti

    Nov 4, 2015 at 3:00 pm

    Hello Mr. Putra,

    Please I have been trying to create or make an analysis of asset , depreciation, accumulated depreciation and NBV for an asset bougth are different years using an excel spread sheet e.g

    Cost Addition Fully depreciated (Dep. P.A) (Accum. Dep) NBV.

    But my challenge is that I can’t get the accum. dep right so as to get the NBV for each year considering the fact that some asset may have attain full depreciation.

    I will appreciate your kind response.

    Regards

    Manti

  34. Mudhara

    Nov 6, 2015 at 9:26 am

    What is the problem if you sometimes take accumulated fund from the income statement your balance sheet will not balance but if you take accumulated figure from cash book, your balance sheet will balance or tally?

  35. Jun G.

    Apr 15, 2016 at 3:44 am

    If an asset e.g furniture and fixtures reached its scrap value after depreciation, would this be reported to BSheet as its scrap value even for continuous operation? Or does it need another assessment as years go by.

  36. Jaya Ediri

    Oct 7, 2016 at 4:00 am

    Hi,
    I just wanted to know how to calculate the cost of the fixtures for depreciation of assets of a property already bought.
    Thanks
    Jaya

  37. Joseph

    Oct 14, 2016 at 10:39 pm

    You should proof read your articles next time if you intend on teaching people. Your math is not right in certain sections.

  38. Emmanuel

    Nov 19, 2016 at 9:35 pm

    Good evening to the Team. I am a Proposal and Policy Personnel in an NGO and am asked to depreciate our Office space.

    I initially put it at 10%,but I was asked to review it.

    My questions now are : should I review it upwards or downwards, and what is the essence of Fixed Assets Depreciation?

    Kindly note that I assumed Office most recently.

    Thank you.

  39. georgia

    Nov 28, 2016 at 10:03 pm

    I am confused, you said in your 1st explanation that the car was bought at $25,000 and had a salvage value of $5,000. So where did you get the $35,000 figure you used in your calculations?

Leave a Reply

Your email address will not be published. Required fields are marked *




Are you looking for easy accounting tutorial? Established since 2007, Accounting-Financial-Tax.com hosts more than 1300 articles (still growing), and has helped millions accounting student, teacher, junior accountants and small business owners, worldwide.

Trending