Depreciation Methods Example

The asset in the scenario below will be put through the different depreciation methods to demonstrate how they differ.

 

 

Asset Cost                                   $125,000

Salvage Value                              $5,000

Useful Life                                   5 years

Convention                                   Full year

Declining percent                         200% (factor of 2)

 

This scenario assumes a full year convention so that no matter when you bought the asset, it is depreciated a full year in both the first and last years. If you have a different convention, modification of the scenario below to reflect this would be necessary. For example, if you purchased the asset in January (on a calendar business year), but have a mid-year convention, the first year of straight line depreciation would automatically be only one half of the depreciation expense amount shown below for year one. Then in the last year of life (year six), you would only have half a year of depreciation as well.

 

 

The straight line method of depreciation depreciates the asset over its useful life by using the same amount every year. The asset is only depreciated for its cost less salvage value, as shown below.

 

Yearly Straight Line Depreciation = Asset Cost - Salvage Value

Useful Life

Yearly Straight Line Depreciation = $125,000 - $5,000

5 years

Yearly Straight Line Depreciation = $24,000

 

Straight Line Depreciation Schedule:

Year 1                    $24,000                              $24,000                                   $101,000

Year 2                    $24,000                              $48,000                                   $77,000

Year 3                    $24,000                              $72,000                                   $53,000

Year 4                    $24,000                              $96,000                                   $29,000

Year 5                    $24,000                              $120,000                                 $5,000 (salvage value)

 

 

The declining balance method is based on the premise that an asset is more useful in its earlier years so depreciation should follow the matching concept of revenue/expense recognition; being greater in the early years and less in the last years of life. The declining balance method does not take the salvage value into account when calculating the yearly depreciation expense (like straight line does); rather it stops depreciating the asset when the useful life is over or when the salvage value amount is reached in the last year of life. In this scenario, our declining percent is 200% (also known as double declining balance). The basic concept is this: double the amount of depreciation is taken each year, based on the previous year's declining asset book value. See the formula below.

 

First Year Declining Balance Depreciation = (Declining Factor/Useful Life) * Asset Book Value

 

First Year Declining Balance Depreciation = (2/5) * $125,000

 

First Year Declining Balance Depreciation = $50,000

 

Declining Balance Depreciation Schedule:

Year 1          (2/5) * $125,000                  $50,000                         $50,000                                   $75,000         

Year 2          (2/5) * $75,000                    $30,000                         $80,000                                   $45,000         

Year 3          (2/5) * $45,000                    $18,000                         $98,000                                   $27,000    

Year 4          (2/5) * $27,000                    $10,800                         $108,800                                 $16,200         

Year 5          (2/5) * $16,200                    $6,480                          $115,280                                 $9,720         

 

The variable declining balance method allows a change in depreciation method part-way through the asset's life; from declining balance to straight line. The change happens when the straight line depreciation amount on the remaining balance equals or exceeds the declining balance depreciation amount for that year. Most of the time this method is used for assets that have higher benefits early in life, but become stable revenue or benefit producers later in life. To demonstrate this method, the double declining balance example shown above will be used to show when the switch to straight line depreciation is appropriate.

 

In year 4, the declining balance depreciation is less than the straight line depreciation ($10,800 vs. $11,000) and therefore straight line depreciation takes over depreciating the remaining book value over the remaining useful life in a straight line fashion using the formula below. This straight line 'test' can be run each year using the formula below.

 

Crossover Test to Straight Line Depreciation = (Asset Cost - Salvage Value) - Accumulated Depreciation

Remaining Useful Life

 

Crossover Test to Straight Line Depreciation in Year 4 = ($125,000 - $5,000) - $98,000

2

Crossover Test to Straight Line Depreciation in Year 4 = $11,000

 

See the column on the far right for the final depreciation expense amounts.

 

Variable Declining Balance (VDB) Depreciation Schedule:

Year 1          (2/5) * $125,000 =$50,000          $50,000               $75,000          $120,000/5 = $24,000                $50,000

Year 2          (2/5) * $75,000   =$30,000          $80,000               $45,000          $70,000/4 = $17,500                  $30,000

Year 3          (2/5) * $45,000   =$18,000          $98,000               $27,000          $40,000/3 = $13,333                  $18,000

Year 4          (2/5) * $27,000   =$10,800          $109,000             $16,000          $22,000/2 = $11,000 (greater)     $11,000

Year 5          (2/5) * $16,200   =$6,480            $120,000             $5,000            $11,000/1 = $11,000 (greater)     $11,000

 

The sum-of-years' digits method is similar to the declining methods but takes a different approach than using the declining book value of the asset. In this method, the sum-of-years' digits, meaning to add up the numbers in the useful life, becomes the denominator. The numerator starts at the useful life and decreases by one year each year as shown below. This is just another way to accelerate depreciation in the early years by using declining years rather than a declining book value. Sum-of-years' digits also takes salvage value into account for each year's depreciation expense, just like straight line.

 

First Year Sum-of-Years' Digits Depreciation = (Year in Useful Life/Sum-of-Years' Digits) * (Asset Cost - Salvage Value)

 

First Year Sum-of-Years' Digits Depreciation = (5/5+4+3+2+1) * ($125,000 - $5,000)

 

First Year Sum-of-Years' Digits Depreciation = $40,000

 

Sum-of-Years' Digits Depreciation Schedule:

Year 1          (5/15) * $120,000               $40,000                              $40,000                                   $85,000    

Year 2          (4/15) * $120,000               $32,000                              $72,000                                   $53,000         

Year 3          (3/15) * $120,000               $24,000                              $96,000                                   $29,000    

Year 4          (2/15) * $120,000               $16,000                              $112,000                                 $13,000

Year 5          (1/15) * $120,000               $8,000                               $120,000                                 $5,000