How To Calculate Straight-Line Depreciation

How To Calculate Straight-LineHere at Depreciation Guru the most searches, questions and page visits we get are for Calculating Depreciation. We have a number of excellent posts in our archive on just this subject (read more about calculating depreciation here). Today, courtesy of the fine folks at The Motley Fool, we add to that knowledge base with an article on calculating straight-line depreciation.

Over time, the value of a company’s capital assets decline. This is a normal phenomenon driven by wear and tear, obsolescence, and other factors. This depreciation in the asset’s value must be accounted for on the company’s income statement and balance sheet to capture the loss in value over time as an expense and as a reduction in the asset’s actual value.

To calculate this capital expenditure depreciation expense, the company’s accounting team must use the asset’s purchase price, its useful life, and its residual value. Here’s how.

In this example, we’ll keep it simple and use the straight-line depreciation method. This method accounts for depreciation by taking the same amount as an expense each year over the asset’s useful life. Let’s assume that a farmer purchases a tractor for $25,000 that he expects will last him 10 years. At the end of this 10-year period, the farmer reckons he can sell the tractor on the used market for $8,000.

Using the straight-line method, we know that we will be creating a constant depreciation expense every year. We also know that the book value of the tractor should equal $8,000 after 10 years (this is its residual, or salvage, value).

To calculate how much should be expensed as depreciation each year, we first subtract the $8,000 residual value from the original $25,000 purchase price. That result, $17,000, is then divided by the number of years in the tractor’s useful life, in this case 10 years, to give us our annual depreciation expense for the tractor. $17,000 divided by 10 years is $1,700 per year.

From an accounting perspective, each year the income statement will show the $1,700 as a depreciation expense. On the balance sheet, each year’s depreciation expense will add into the accumulated depreciation account, which is subtracted from the tractor’s purchase price to give its book value, or net asset value. Depreciation is a non-cash expense. In the tractor example above, the only time the farmer actually reduced his cash on hand was when he purchased the tractor. For the next 10 years, though, the tractor spent thousands of hours around the farm and in the fields, rain or shine. The farm needs a working tractor to operate; every day the tractor fires up and gets to work is one day closer to the time it will need to be replaced. When that time comes, that means spending cash for a new tractor.

So while the tractor’s depreciation expense is a non-cash expense for all the years it is in use on the farm, the tractor was actually losing real value that will one day require a cash expense. Depreciation expense is just our way of accounting for that reality over time, balancing the fact that it costs cash to purchase an asset today and to replace it in the future, but we can only expense these purchases with the asset’s use over time.

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Questions? Comments? Let us know in the comments section below.

More information about Bassets eDepreciation software can be found at Bassets.net or depre123.com. At Bassets register for our live webinar, download a free evaluation copy and get a personalized pricing estimate. At depre123 try out our Free Depreciation Calculator and check out our cloud based fixed assets application.

Declining Balance Method of Depreciation Formula

Declining balance is a form of accelerated depreciation that will depreciate more aggressively than the straight line method. This method is appropriate when an asset has higher functionality in the early years of use and becomes obsolete quickly. Declining or reducing balance methods ensure that more depreciation is accounted for in the first few years. Fixed assets like computer equipment are a good example since they are typically only used for a couple of years and then replaced.

Here is a spreadsheet showing the basic math behind a declining balance formula:

Declining Balance Method

In the example, there are 3 basic values needed to complete the calculation:

  1. Cost – the purchase price of the asset
  2. Method – 200% represents a double declining balance
  3. Years – number of years the asset will be in service

This example uses 10 years to keep the calculated numbers nice and clean but most equipment under declining balance would typically be depreciated over 3, 5 or 7 years. The spreadsheet formula in cell A7 shows one divided by the number of years to determine the straight line percentage. This value is then multiplied by a factor (declining balance percentage i.e. 125, 150, 175, 200 divided by 100) to calculate a depreciation rate. This rate is then multiplied by the remaining balance, which in the first year is the initial cost.

To continue this calculation you could enter (C4-C8)*C7 in cell C9 to calculate the second year. This formula is very similar to the one in C8 except now it calculates with the remaining balance (cost minus prior depreciation) and uses that value in place of cost. You could then continue this formula for each remaining year until the calculated annual number is less than the straight line amount, at that point and forward you can use the straight line amount until the asset is fully depreciated.

A straight line method will evenly spread the cost of an asset over its entire life while a declining balance method will result in a declining depreciation charge each year. As you can see, this calculation is much more complicated even for just a single asset record. These formulas can get very confusing when you are tracking a larger number of assets.

Let the Depre123 depreciation calculator take out the guess work. Just enter 3 simple values (Cost, Date, Class) and get all the answers. The calculator is a great way to view the depreciation results for a handful of assets. If you manage hundreds or thousands of fixed asset records then a trial of the full Depre123 application can demonstrate how to simplify the entire process of fixed asset management.

Questions? Comments? Let us know in the comments section below.

More information about Bassets eDepreciation software can be found at Bassets.net or depre123.com. At Bassets register for our live webinar, download a free evaluation copy and get a personalized pricing estimate. At depre123 try out our Free Depreciation Calculator and check out our cloud based fixed assets application.

Capital Cost Allowance (CCA) for Canadian Assets

Q and AIn Canada you can claim depreciation with Capital Cost Allowance (CCA). Can you explain the CCA Classes and show a sample calculation?

Yes, Canadian depreciation utilizes asset classes based on the type of asset to determine the appropriate depreciation percentage. Here is a basic chart of the rates:

Capital-Cost-Allowance-w2

There is a complete list of Canadian Asset Classes at the Canada Revenue Agency with much more detail. Each class depreciates at a different percentage based on the type of asset such as building, furniture or other type equipment. Once you determine the correct class then use the corresponding rate in your depreciation calculation. 

For example, if you purchased a laptop computer for $1,000 this would fall into class 10 and have a 30% rate. In the first year you multiply $1,000 times .30 to get $300 and then apply a half year convention to get $150. This leaves an $850 balance which gets multiplied by .30 to get $255 in the second year. In the third year the balance would be $595 ($850 – $255) and would be multiplied by .30 to result in $178.50. The calculations continue this way using the remaining balance multiplied by the rate.

For more information on Canadian Capital Cost Allowance and calculating depreciation see some of our other posts: 

Questions? Comments? Let us know in the comments section below.

More information about Bassets eDepreciation software can be found at Bassets.net or depre123.com. At Bassets register for our live webinar, download a free evaluation copy and get a personalized pricing estimate. At depre123 try out our Free Depreciation Calculator and check out our cloud based fixed assets application.

Depreciation Basics – What You Need to Know

retired computerAlthough we have looked at the basics of depreciation a number of times, it is never a bad subject to cover, especially during tax season.

For some, tax season is a time of dread. But not for Small business owners as they forward to asset depreciation, which is the decrease in value of an asset that qualifies as an income tax deduction. According to the fine folks at Paychex “Taxpayers can recover some of the costs of certain property over time…In other words, it’s almost like a yearly allowance that represents the reduction in value of the asset. Ensuring you receive the total tax deduction available to you requires a fundamental understanding of how asset depreciation works:”

  • Assets that depreciate can be either tangible or intangible. Tangible assets are physical assets, such as company cars and machinery. Intangible assets can include software and copyrights. In order for an item to be counted for depreciation, the taxpayer must own the item, use it for business, and have continued use over one year.
  • Depreciation can be spread out over a number of years, giving businesses tax relief in more than one accounting period. Once the property class of the item to be depreciated has been identified from the item list in IRS Publication 946, find the asset’s “placed in service” date. This is the date you started using the asset, but also the date from which asset depreciation begins. Then you can determine the time frame (years) to use for the asset’s recovery period (period of time when depreciation can be spread out).
  • Though there are different depreciation systems, the IRS recommends the Modified Accelerated Cost Recovery System (MACRS). With this system in place, you will have to select the most appropriate depreciation method and convention for calculating depreciation on an item. The most common of these is the General Depreciation System (GDS), though you may be required by law to use the Alternative Depreciation System (ADS).
  • Asset depreciation, at its most basic, is a calculation of the asset’s initial cost (or other basis for depreciation) multiplied by the percentage used for business. From this figure, subtract any credit or deductions that apply to the asset, including expensed portions or bonus first-year depreciation.
  • Calculating depreciation may seem like a challenging part of small business taxation, but it is simplified by using the tables and worksheets found on the IRS website. One example is the MACRS worksheet, which can help keep your figures organized. Information is set up in a grid formation, including each year of the recovery or depreciation period, followed by the cost, allowed percentage to claim for business depreciation, and the corresponding dollar figure. The rates listed in the MACRS percentage tables will help you determine the basis for depreciation. Take the time to read the instructions and follow the steps carefully. The end result could help your business get the most benefit from this valuable income tax deduction.

For more information on asset depreciation and how to calculate it, visit IRS Publication 946: How to Depreciate Property.

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Questions? Comments? Let us know in the comments section below.

More information about Bassets eDepreciation software can be found at Bassets.net or depre123.com. At Bassets register for our live webinar, download a free evaluation copy and get a personalized pricing estimate. At depre123 try out our Free Depreciation Calculator and check out our cloud based fixed assets application.

How To Fill Out Form 4562

How to Fill Out Form 4562If you are a business owner and purchased for business or investment purposes any equipment or machinery in 2014, bought a building or other property, or used a vehicle for business, you need to complete Form 4562, Depreciation and Amortization.

The following is an edited version of an article on Investopedia by Barbara E. Weltman that shows how to complete the form under the most common circumstances. (Read Full Article Here)

Part I

This part of the form is used to elect to expense tangible property, off-the-shelf software and certain types of realty (e.g., a greenhouse) placed in service in 2014 (called the Section 179 deduction). The maximum amount of this deduction is $500,000 for machinery and equipment (or $250,000 for qualified leasehold, retail and restaurant improvements).

Regardless of the deduction amount, you must apply the limitation that restricts the Section 179 deduction to the extent of your business profits (called “taxable income” without regard to certain deductions) for the year.

Part II

This part of the form is used for a special depreciation allowance (also called “bonus depreciation”), which is a 50% allowance claimed in the year that eligible property is placed in service. (For 2015, it’s been eliminated unless reinstated by Congress.)

Do not complete this part for:

Property that is not “eligible property.” Only new property, and not pre-owned property, is eligible.
“Listed property,” which is defined later (in Part V).

Part III

This section is for basic depreciation (other than depreciation for listed property, which is entered in Part V) under the Modified Accelerated Cost Recovery System (MACRS) that was created in 1986 and continues to apply today. A single entry on line 17 is used to report deductions for assets placed in service before 2014 (refer to your prior tax returns or any worksheets you may have retained to determine the amount to enter here).

Details about assets placed in service in 2014 are entered on lines 19a through 19i.

Part IV

This part of the form is merely a summary from parts I, II and III, as well as listed property in Part V. Line 22 is the key entry; it is the amount of depreciation that is deductible. The amount on line 22 is reported on the appropriate line of your tax return.

Part V

This section is for claiming write-offs for listed property: cars weighing 6,000 pounds or less, pickup trucks, computers and peripheral equipment, video recording equipment and other property specifically called “listed property.”

Section A is for the depreciation allowance for listed property, including the Section 179 deduction and bonus depreciation.

Section B is used to provide information about vehicles used by sole proprietors, partners or other “more than 5% owners” or people related to these business owners.

Section C is used by an employer to report certain information on employee use of company vehicles.

Part VI

This part is for any amortization you claim. Amortization costs that begin in 2014 are entered on line 42 (along with a description of the costs and other information); amortization for costs that began before 2014 is entered on line 43.

The Bottom Line

If you didn’t acquire any assets in 2014 and are merely depreciating the cost of assets purchased in prior years, you may not need to complete this form. Not sure about this, or whether you’re up to the task of handling this form? Review the IRS instructions to Form 4562 or consult a tax professional.

This article highlights the basic process of filling out Form 4562. For a step by step version Read Full Article Here:

Questions? Comments? Let us know in the comments section below.

More information about Bassets eDepreciation software can be found at Bassets.net or depre123.com. At Bassets register for our live webinar, download a free evaluation copy and get a personalized pricing estimate. At depre123 try out our Free Depreciation Calculator and check out our cloud based fixed assets application.