How to Calculate Depreciation

With all of the rules and regulations governing depreciation, and the various methods of depreciation, one may find it difficult to actually calculate depreciation.  This post will hopefully serve as a basic comprehensive guide to calculating depreciation under different circumstances.  The following examples are based upon use of half year averaging convention.

Straight-Line Method:
Annual Depreciation Expense = (Cost of Asset – Salvage Value)/Estimate Useful Life

Example:  A machine costs $75,000 to purchase and has estimated useful life of five years, upon which time it will have an estimated salvage value of $5,000.  Using the formula above, we can determine that annual depreciation will be $14,000 per year.  ($75,000-$5,000)/5 Years = $14,000.  The effect of the half year averaging convention is to reduce the first year depreciation by 1/2.  Therefore, the 1st year’s depreciation of $14,000 will be reduced to $7,000  The simplicity of this calculation is why many prefer to use this method.

(Cost – Salvage)/Recover Period
($75,000 – $5,000)/5=$14,000 with half year convention.
Note:  $14,000 in this example is normal annual depreciation.  Based on the following assumptions, the allowed depreciation is:
-Tax/accounting year end of 12/31
-Annual depreciation of $14,000
-With half year convention, 1/2 or $7,000 is allowed.

Therefore:

  • Acquired in January =$7,000/12=$583.33 per month allowed
  • Acquired in March = $7,000/10=$700 per month allowed
  • Acquired in August=$7,000/5=$1,400 per month allowed
  • Acquired in December=$7,000/1=$7,000 for the month of December


Declining Balance Methods:

(Book value at beginning of year) X (Depreciation Rate)
Book Vale = Cost of asset – accumulated depreciation

Using the same example as before, let’s calculate the annual depreciation using the double declining balance method. The straight-line depreciation rate would be 20%.  (100%/5 years = 20%)  Under the double declining balance method, the rate would be 40% (20% x 2).  Below are years 1-10 and their corresponding depreciation values.  Assume that the machine was bought and placed in service July 1.

Note:
For 200% Declining Balance:  (1/Recovery Period) X 2 i.e.  1/5=.20–> .20 x 2 = .40
For 150% Declining Balance:  (1/Recovery Period) X 1.5
i.e. 1/5=.20–> .2 X 1.5 =.30

  • Year 1:  $75,000 X 40%=$30,000** To reflect the half-year convention divide $30,000 by 2 to get $15,000 as the amount of depreciation for the first year.
  • Year 2:  ($75,000 – $15,000) X 40% = $24,000 of depreciation.
  • Year 3:  ($75,000 – $39,000) X 40% = $14,400 of depreciation.
  • Year 4:  Here there is a switch back the straight line method as the amount depreciated under the double declining balance would be less than under the straight line method.  Thus, depreciation is $8,640
  • Year 5:  Depreciation will be $7,960 to maintain a book value equal to the salvage value of $5,000.

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