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.
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.
- 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.
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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