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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36 thoughts on “How to Calculate Depreciation

  1. i am struggling with this question..pls help me….

    UMP Pharma Sdn. Bhd has decided to purchase a new tableting machine at RM950,000 for the production of Vitamin C chewing tablets. During the purchasing, the old tableting machine has been traded-in with a book value of RM 110,000. The new machine qualifies as 10-year property. The equipment’s salvage value at that time is estimated at RM50,000 during the end of 10 years period, and the income tax rate stands at 25%, perform after tax economic analysis for 10 years period.

    i. Determine the depreciation amounts using Straight Line (SL), Double Declining Balance (DDB), Sum of Years Digits (SOYD) and MACRS Methods.
    ii. If UMP Pharma S/B sold the machine at RM 805,000. The accumulated depreciation is RM 148,500. With income tax rate at 25%, determine the tax liability resulting from this sale.

    • dGuru

      Hello Arasi,
      Just a note – MACRS is DDB.
      Sold = 805,000
      Accumulated Depreciation = 148,5000

      Cost = 950,000
      Minus Old (110,000)
      Net = 840,000
      Salvage Value = (50,000)
      Net 790,000

  2. In your Declining Balance Example…

    For Year 4, I understand that you go back to the Straight-Line Method, but why is it only a deduction of $8,640 and not the $14,000 that was initially calculate for the Straight-Line Method?

    Why wouldn’t Year 4 depreciate $14,000 and Year 5 depreciate $2,600 to leave the remaining $5,000 salvage value?

    Thanks for your help in clarifying this!

    • dGuru

      Hello Jon,
      The switch to Straight-Line is not the standard annual number from a Straight-Line calculation. It is the net book value at the end of a year divided by the remaining number of years in the calculation. So as you can see in the 3rd year, the NBV/2.5 = 1152 and since the NBV of 2880 at 40% is 1152 and NBV/2.5 = 1152. Therefore the rule states if the NBV/remaining number of years is equal to or less than what the DDB calculation would generate, then you switch to the Straight-Line method.

      In regards to the salvage value, the typical calculation with salvage value is the cost of the asset less salvage value being depreciated down to a NBV equal to the salvage value.

  3. Hi.. I need help.
    Calculate the depreciation on motor van at 20% on cost annually(show the depreciation for the month) the cost is $822400

  4. Hello I need help with this example…

    The management expects that the aircraft which cost 1000.000.000, will benefit the company in 10 years. It is expected that the machine will be used fairly evenly series. The residual value amounts to ISK 100 million (note that the plane was capitalized in whole).
    The management company will write off the property in 40 years, but it is expected that its use will change much over their lifetimes. They estimate no residual value.

    a)Select the appropriate amortization methods and bring appropriate items for the assets at the end of 2014.

    • dGuru

      Hi Kris,
      Not exactly sure what the first number is but we have settled on $1 Billion purchase price. There are also some conflicting info in your question and we don’t understand what you mean when you say “will benefit the company in 10 years”. Anyhow, let with the $1 billion amount and assume a 40 year recovery period with a $100 million salvage value. Therefore $900 million over 40 years or $22,500,000.00 per year.

  5. Depreciation under WDV method Rate of depreciation every year change or not . if will change how to calculate of Depreciation method.

  6. Hi
    Please help, i would like to how to calculate the following
    Cost of the machine =R800 000
    Useful life of machine= 10yrs
    Depreciate under diminishing method.

    Thank you!

  7. Hi… i have problem, how do i calculate depreciation on cost for example. Furniture at cost price 100 000 calculate furniture at 10% per year on cost from 31 December to 31 December 2014

    • dGuru

      Hello Imelda,
      We are assuming that you are stating the year is from 31 December 2013 to December 2014. Therefore 10% per year.
      $100,000 at 10% per year = $10,000.

  8. A machine is costing Rs. 110,000 and expected to run for 10 years., at the end of which its scrap value is likely to be Rs. 10,000. The machine is expected to run 2000 hours per year on the average. What is the depreciation charges per hour of the machine.

    • dGuru

      Hello Grace,
      Cost = $110,000
      Salvage = $10,000
      Depreciation Basis = $100,000

      10 years at 2,000 hours per year
      2000 x 10 = 20,000 hours
      $100,000 ÷ 20,000 hours = $5/hr

  9. help to resolve that question : Y Company has a quarterly accounting period. On 3/22/02, Y acquired a computer for $12,000. Management estimates the useful life to be 3 years. At the end of 3 years, the computer will have no resale value. a. Using straight-line depreciation, compute depreciation expense for the quarters ended 3/31/02, 6/30/02 and 9/30/02

    • dGuru

      Hello Habimani,
      Cost = $12,000
      3 years (36 months) at Straight Line = $333.33/month

      Asset acquired 3/22/2002
      Quarter ending with monthly depreciation:
      3/31/2002 = $333.33
      6/30/2002 = $1,000.00
      9/30/2002 = $1,000.00

      Quarter ending with quarterly depreciation (4 quarters/yr):
      3/31/2002 = $1,000.00
      6/30/2002 = $1,000.00
      9/30/2002 = $1,000.00

  10. I request you a help. how can I calculate the quarterly depreciation of an assets required on 22 march 2002? for example: Y Company has a quarterly accounting period. On 3/22/02, Y acquired a computer for $12,000. Management estimates the useful life to be 3 years. At the end of 3 years, the computer will have no resale value. a. Using straight-line depreciation, compute depreciation expense for the quarters ended 3/31/02, 6/30/02 and 9/30/02

  11. Hello can u help me how to depreciate a Furniture In a annual depreciation of 5%? In a 14 month period which method should i use?

    • dGuru

      Hello Justin,
      For furniture, the IRS recovery period is 7 years, or 84 months. GAAP has the same recovery period. The IRS method is a 200% declining balance with a half year convention. The GAAP method is Straight Line with a half year convention.

    • dGuru

      Hi ilene,
      The depreciable basis of an asset can be reduced by various tax credits. However, VAT, or Value Added Tax, is NOT included in the list from the IRS.

  12. If the financial year extended to 3 more months (Jan’14~Mar’15), How can i calculate the depreciation?
    -Straightline method-

    • dGuru

      Hello Dummie,
      I am afraid that we will need more info. Was the year entered from 12 months to March 2015. In other words a 15 month year.

    • dGuru

      Hello Dani,
      We need further information to be able to help you out. What kind of asset type is it. We will also need to know if the calculation you are using is for Federal Tax or Financial Book.

  13. 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.

  14. 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.

  15. 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

  16. 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

  17. 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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