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.

Unfortunately, many issues of depreciation are not as straightforward as this, and require a great deal of in-depth calculations.  Should you have any specific questions, feel free to ask them here or on the questions page.  Also, here is a link to a useful and free depreciation calculator.

More information about Bassets eDepreciation software can be found at Bassets.net. While there you can set up a demonstration, download a free evaluation copy and get a personalized pricing estimate.

9 thoughts on “How to Calculate Depreciation

  1. 4) Depreciation on vehicles, 20% per annum, straight line

    Vehicles at cost 15,000
    Depreciation on vehicles 3,000

    5) Depreciation on office equipment, 10% per annum, straight line

    Office equipment at cost 10,000
    Depreciation on office equipment 5,000

    I am struggling on this question please could you help me I am new to this

    • 4) Depreciation on vehicles, 20% per annum, straight line

      Vehicles at cost 15,000
      Depreciation on vehicles 3,000

      Answer: 20% per annum, straight line indicates a five year recovery period. Therefore, $15,000 divided by 5 years equals $3,000 per year.

      5) Depreciation on office equipment, 10% per annum, straight line

      Office equipment at cost 10,000
      Depreciation on office equipment 5,000

      Answer: 10% per annum, straight line indicates a ten year recovery period. Therefore, $10,000 divided by 10 years equals $1,000 per year.

  2. In looking at table 1 in rev proc 87-57, there is one table for the double declining and 150% declining switching to straight line, how do the same percentages apply to both?

    • The answer is very simple. Table 1 is used for the General Depreciation System. For personal property, MACRS, GDS – General Depreciation System, has six recovery periods, three depreciation methods and three first year conventions that are applied as follows:

      Double (200%) Declining Balance depreciation method:
      o Recovery Periods allowed: 3, 5, 7 and 10 years
      o First Year Conventions: Half Year and Mid Quarter

      150% Declining Balance depreciation method:
      o Recovery Periods allowed: 15 and 20 years
      o First Year Conventions: Half Year and Mid Quarter

      Straight Line (Computer Software):
      o Recovery Periods allowed: 3 years
      o First Year Conventions: Full Month

      Straight Line (All Personal Property, except software):
      o Recovery Periods allowed: 3, 5, 7, 10, 15 and 20 years
      o First Year Conventions: Half Year and Mid Quarter

      As you can see, the 200% Declining Balance percentages only apply to 3, 5, 7 and 10 year recovery periods. The 150% Declining Balance percentages only apply to the 15 and 20 year recovery periods. Please refer to IRS Publication 946 Depreciation for complete details as to how annual depreciation is calculated. Publication 946 also contains the Table of Class Lives and Recovery Periods that lists most assets by their type or class and the allowed recovery period assigned to that class of asset. This publication can be down loaded from http://www.irs.gov.

  3. hello. im really confuse about the formula to find the annual rate of dep.. which one are correct? is it r = 1- square root with the power of n ( salvage value divide by cost ) OR r = 100/ estimated life times with two.. please reply. i really need your help.

    • I am sorry to say, but neither one of the two suggested formulas make sense. The formula for financial book in its simplest terms is as follows:

      · Cost of the asset minus salvage value equals depreciable basis with a straight line method
      · The data of acquisition of the asset equals the month in which depreciation starts
      · Divide the depreciable basis by the number of months in the recovery period. For example, three years would equal 36 months.
      · That monthly number is applied on a monthly basis until the net book value (depreciable basis minus accumulated monthly depreciation) equals zero
      · Therefore: $1,000.00 Cost
      (500.00) Salvage Value
      ————-
      500.00 Depreciable Basis \ 36 equals $13.89 per month for 36 months adjusted for the rounding error

  4. i have same problem, which Dee Dee alredy have… that is when to switch to straight line dep: in double declining half-year convention????

    • Under the IRS General Depreciation System (GDS) there is no Asset Class with a 6 year recovery period and the taxpayer is allowed to use accelerated depreciation methods, such as the 200 Percent Declining Balance method.

      Under the IRS Alternative Depreciation System (ADS) there are eleven Assets Classes with a 6 year recovery period. However, the taxpayer is not allowed to use accelerated depreciation methods, such as the 200 Percent Declining Balance method that was asked about. In addition, if the taxpayer is required to use ADS for the following reasons, Bonus Depreciation is not allowed:

      • Tangible property used outside of the USA
      • Tax-exempt use property leased to a tax-exempt entity
      • Tax-exempt bond-financed property
      • Property imported from a foreign country with trade restrictions and/or other discriminatory acts
      • Listed property, such as automobiles or trucks that are used 50 percent or less for business purposes

      Purchase Price vs Depreciable Basis: The IRS has very specific rules that determine the dollar amount of an asset that may be depreciated, which is a follows: In very simple terms, the Purchase Price or cost of the asset reduced by any Section 179 Expense deduction and/or Bonus Depreciation equals the Depreciable Basis. For example:
      Purchase Price: 100,000.00
      Section 179 Expense Deduction: 25,000.00
      Net: 75,000.00
      Bonus Depreciation (50% of Net) 37,500.00
      Depreciable Basis 37,500.00

      The Depreciable Basis of an asset is the dollar amount that is used for both the 200 Percent Declining Balance calculation and the Switch to Straight Line. Please refer to the IRS Publication 946, How to Depreciate Property, page 35 “Figuring Depreciation under MACRS”. This publication can be downloaded from the following link: http://www.irs.gov/pub/irs-pdf/p946.pdf

  5. If I take Bonus depreciation in the first year of a 6-year asset type, it appears that I should switch to straight-line in the 3rd year. My friend disagrees and says I have to recalc adjusted basis without bonus to determine when to switch. Do I have to add back the bonus depreciation to the basis in order to calculate when to switch to straight line?

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