What is a Depreciation Schedule?
A depreciation schedule or chart helps businesses keep track of long-term assets and gives a look at how they’ll depreciate over time.
It calculates an asset’s depreciation expenses based on the date of purchase, initial cost, useful life (how long a company intends to use it), and tracks beginning and ending accumulated depreciation, or the value of the assets when it is replaced. For accounting purposes, depreciation schedules typically include the following information:
The two most common methods used to calculate depreciation expense are the straight-line method and the accelerated method. A straight-line method subtracts the salvage value of an asset and subtracts it from the initial cost. The result is then divided by an estimated number of useful years and the business expenses an equal amount of depreciation for each year.
An accelerated method writes off depreciation costs more quickly so to minimize taxable income.
Which calculation a company uses affects the income statement and balance sheet in different ways. In other words, how a company uses this function is important for analyzing its authentic bottom line.
Why is a Depreciation Schedule Important?
Businesses use it to report asset use to their stakeholders. Deprecation also brings down the historical value of assets. Stakeholders can review this information and know when to expect replacement assets purchased by a company. For example, a company with design equipment or hardware will often replace these items at some time during operations or during the life of the business. When accumulated depreciation nears the asset’s historical cost, a replacement purchase may be coming up soon.
Anything you own with a dollar value tied to it is an asset. A tangible asset is anything of value you can touch.
A fixed asset is a type of tangible asset that would take time to liquidate. Examples include office furniture, a warehouse or company vehicle. Inventory items aren't fixed assets as they are quick to sell.
The IRS lets you claim less income when buying expensive fixed assets for business use.
Here are the rules:
1.) You can't claim the entire cost in a single year.
Instead, you depreciate the item and claim a percentage of its value each year of its useful life.
2.) You must own it.
A lease will not do. The owners of rented property or equipment are the only ones who can claim right-offs.
3.) You must use it to turn a profit or within your business.
The self-employed can depreciate their work computer and claim the depreciated value. A business owner can do the same with owned office space.
4.) The asset's useful life estimate is greater than one year.
Useful life is a projection of how long a fixed asset has before it becomes obsolete. In Publication 946, Appendix B the IRS details the useful life estimates of most fixed assets. They base their conclusions on the Modified Accelerated Cost Recovery System (MACRS).
Ways to Depreciate an Asset
In most cases, the longer you have a piece of equipment or property, the less value it brings to the table. The reduction of value from a fixed asset's original cost is called depreciation. There are four main types of depreciation.
Straight-line and unit-of-production methods are for a more accurate picture of an asset's value to a company. They are most often used for accounting purposes, but you can also use them for tax purposes.
The double-declining and sum-of-the-years digits methods are better suited for taxes. Both methods front-load a large portion of the expense in the first year. This allows startups and businesses with a lot of bills to recoup some of their costs sooner.
We'll go into this more in a moment. First, there are some new terms to learn before we move on.
Purchase Price: The price you paid to get an asset. Keep the original receipt as both a reminder and proof of cost.
Salvage Value: The dollar amount you expect to receive when selling a fixed asset at the end of its useful life. Some assets aren't worth anything once depleted and have a $0 salvage value.
Depreciation Rate: The percentage amount a fixed asset depreciates each year.
DEPRECIATION RATE = PURCHASE PRICE / DEPRECIATION AMOUNT
Sum-of-the-Years Digits (SYD): The number you get by adding each digit of a fixed asset's expected useful life span. Seven years equals 1+2+3+4+5+6+7 for a total of 28.
Accumulated Depreciation: The dollar amount a fixed asset has depreciated over the course of its useful life.
Book Value: The value of a fixed asset less accumulated depreciation.
Depreciation Schedule: A table or chart that shows the depreciation of an asset over time.
To use straight-line depreciation, divide an asset's cost evenly over each year of its useful life until the value equals its salvage cost. This depreciation type shows a balanced drop in value for assets without a set usage pattern.
The equation is simple:
STRAIGHT-LINE DEPRECIATION = ASSET PRICE - SALVAGE VALUE / USEFUL LIFE
Let's imagine we buy a new office printer for $22,000 and want to depreciate its value.
The printer is high-end. We expect it to last for at least five years. When the printer's useful life is over, we can resell it for about $2,000.
$22,000 ASSET PRICE - $2,000 SALVAGE VALUE / 5 = $4,000 STRAIGHT-LINE DEPRECIATION
The depreciation for the printer will be $4,000 per year for the next five years. Straight-line depreciation is always a fixed rate.
Where the straight-line method has a fixed rate of depreciation, unit-of-production is variable. This is because it depreciates an asset based on the number of times it's used.
To calculate unit-of-production depreciation, the asset must have a measurable production rate. For example, if we track the number of prints made on our new printer, we can depreciate the asset based on usage.
To calculate unit-of-production depreciation, use this formula:
ASSET PRICE - SALVAGE PRICE / TOTAL UNITS IN USEFUL LIFE * UNITS PRODUCED = UNIT-OF-PRODUCTION DEPRECIATION
We expect our printer to make 2,160,000 copies before it expires. The first year we make 550,000 prints. The next year we make 225,500.
$22,000 ASSET PRICE - $2,000 SALVAGE VALUE / 2,160,000 TOTAL PRINTS * 550,000 PRINTS MADE = $5,092.59 UNIT-OF-PRODUCTION DEPRECIATION
If we run the same calculations for the following year, we get a depreciation amount of $2,087.96. We'd keep going in this manner until our accumulated depreciation equaled the net asset price of $20,000.
Double-declining depreciation uses an asset's straight-line depreciation rate and first-of-the-year book value. This maximizes the amount of depreciation written off in its first year of use and decreases it every year thereafter.
The first-year equation is as follows:
DOUBLE-DECLINING DEPRECIATION = 2 * STRAIGHT-LINE DEPRECIATION RATE * FIRST-OF-THE-YEAR BOOK VALUE
The straight-line depreciation of our printer is $4,000. The book value for the first year is the full price of $22,000 while the net value is $20,000. Salvage price is not taken out for double-declining depreciation.
$4,000 DEPRECIATION / $20,000 NET ASSET PRICE = 20% STRAIGHT-LINE DEPRECIATION RATE
2 * .2 STRAIGHT-LINE DEPRECIATION RATE * $22,000 FIRST-OF-THE-YEAR BOOK VALUE = $8,800 DOUBLE-DECLINING DEPRECIATION
If we continue this to the second year and beyond, the depreciation schedule would like this:
YEAR 2: $13,200 BOOK VALUE | $5,280 DEPRECIATION
YEAR 3: $7,920 BOOK VALUE | $3,168 DEPRECIATION
YEAR 4: $4,752 BOOK VALUE | $1,900.80 DEPRECIATION
YEAR 5: $2,851.2 BOOK VALUE | $851.20 DEPRECIATION
Note that the last year's depreciation is equal to the difference between the salvage value and the 5th-year book value. If we add up the accumulated depreciation up to year 4 we get $19148.80. We only need $851.20 to reach our depreciation goal of $20,000.
Sum-Of-The-Year's Digits Depreciation
Sum-of-the-years digits depreciation lessens with remaining years of usefulness. Double-declining depreciation decreases with book value. SYD's results are also distributed more evenly.
They are otherwise similar in that both can decrease the bulk of depreciation within the first year.
To calculate SYD depreciation, use the following equation:
(YEARS OF REMAINING LIFESPAN / SYD) * NET ASSET BOOK VALUE = SYD DEPRECIATION
Our printer has five years of useful life. That makes its SYD a total of 15 (1 + 2 + 3 + 4 + 5). Our first year's depreciation calculations look like this:
(5 YEARS OF REMAINING LIFESPAN / 15 SYD) * 20,000 NET ASSET BOOK VALUE = $6,666.67 SYD DEPRECIATION
Each year, the SYD decreases and changes the depreciation rate. If we follow through to the end of the printer's life cycle, we'll end up with the following depreciation schedule:
YEAR 2: 10 SYD | $13,333.33 NET ASSET BOOK VALUE | $5,333.33 DEPRECIATION
YEAR 3: 6 SYD | $8,000 NET ASSET BOOK VALUE | $4,000 DEPRECIATION
YEAR 4: 3 SYD | $4,000 NET ASSET BOOK VALUE | $2,666.67 DEPRECIATION
YEAR 5: 1 SYD | $1,333.33 NET ASSET BOOK VALUE | $1,333.33 DEPRECIATION
Because SYD works off of net value, the final net amount is also the final depreciation amount. If we add up the accumulated depreciation for all five years, it'll come to $20,000.
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