For example, suppose a company purchases a $75,000 vehicle that will be used for five years. The company should not record the whole cost of that vehicle in year in which it was purchased. Since it will use the vehicle for its entire useful life, it is more accurate to spread the cost of the vehicle over a five year period on financial statements.
In this publication, the IRS refers to useful life as the recovery period of a fixed asset. Vehicles such as cars, taxis, buses and trucks, for example, have a five-year recovery period. Although a business may own a vehicle for more than five years, the IRS thinks it is not likely to continue to use it for business purposes after five years. So the IRS allows the business to depreciate the cost of the vehicle over five years.
Include the sales tax, shipping and installation costs in the total cost of the asset. [7] X Research source The salvage value is the amount for which you could sell the item at the end of its useful life. It is subtracted from the expense of the item when calculating the cost that is to be depreciated. [8] X Research source Use Publication 946 from the IRS to determine the useful life for the asset.
For example, suppose a company purchased a vehicle for $60,000 and the vehicle has a $10,000 salvage value and a five-year useful life. Calculate the depreciable asset cost with the equation $60,000 - $10,000 = $50,000. Divide the useful life (in years) into 1 to calculate the depreciation rate. Use the equation 1 / 5 = . 2. The depreciation rate is 20 percent. Multiply the depreciation rate by the depreciable asset cost to calculate the annual depreciation amount. Use the equation $50,000 x . 2 = $10,000. The company will record $10,000 of depreciation on the vehicle every year.
The idea is that the equipment generates more revenue in the early years of its life than in later years as it becomes less productive. Therefore it is more accurate to record more of the expense through depreciation earlier and less later on as the equipment’s productivity declines.
For example, if a straight-line depreciation rate for an asset is 20 percent, then the accountant would use double that amount, or 40 percent, for the double declining balance depreciation method.
Using the same example as above, suppose a company purchased a vehicle for $60,000 and the vehicle has a $10,000 salvage value and a five-year useful life. Calculate the straight line depreciation rate with the equation 1/5 = . 2. Double the depreciation rate with the equation . 2 x 2 = . 4. The double depreciation rate is 40 percent. Calculate deprecation for the first year with the equation $60,000 x . 4 = $24,000. This is the amount of depreciation that will be recorded in year one. Calculate the book value by subtracting the amount of depreciation already recorded from the original cost. Use the equation $60,000 - $24,000 = $36,000. This is the amount of the equipment that hasn’t been depreciated. Calculate the depreciation amount for year two by multiplying the book value by the accelerated depreciation rate. Use the equation $36,000 x . 4 = $14,400. This is the amount of depreciation that will be recorded in year two. Calculate the remaining book value using the equation $60,000 - $24,000 - $14,400 = $21,600. This is the amount that remains to be depreciated. Calculate depreciation for year three by multiplying the book value by the accelerated depreciation rate. Use the equation $21,600 x . 4 = $8,640. This is the amount of depreciation that has to be recorded in year three. Calculate the remaining book value using the equation $60,000 - $24,000 - $14,400 - $8,640 = $12,960. Calculate depreciation for year four by multiplying the book value by the accelerated depreciation rate. Use the equation $12,960 x . 4 = $5,184. Adjust the depreciation for year four for the salvage value. Remember that the equipment has a salvage value of $10,000. If you applied the entire depreciation amount of $5,184 to the book value, it would leave you with $7,776, which is less than the salvage value. You can only record depreciation up to the amount where the book value equals the salvage value. Therefore the year four deprecation value must be calculated by subtracting the salvage value from the book value using the equation $12,960 – $10,000 = $2,960.
Understand the cash flow and tax implication of using accelerated depreciation. If a company books higher depreciation in the near term, then for that year its cash flow will be reduced. It also reduces the amount of taxable income, deferring tax payments into later years.
Using the same example as before, suppose a company purchased a vehicle for $60,000 and the vehicle has a $10,000 salvage value and a five-year useful life. Calculate the SYD. Use the equation 5(5+1) / 2 = 15. Calculate the depreciation rate for year one by dividing the years remaining in useful life by the SYD. In year one, the years remaining in useful life is 5. Use the equation 5/15 = . 3333. Apply this rate to the cost of the equipment less the salvage value to calculate the depreciation amount for year one. Use the equation ($60,000 -$10,000) x . 3333 = $16,665. Record $16,500 in depreciation expense for year one. Calculate the depreciation rate for year two. In year two, the remaining years in useful life is 4. Divide 4/15 = . 2667. Apply this rate to calculate the depreciation. Depreciation is ($60,000 -$10,000) x . 2667 = $13,335. Calculate the depreciation rate for year three using the equation 3/15 = . 2. Depreciation is ($60,000 - $10,000) x . 2 = $10,000. Calculate the depreciation rate for year four using the equation 2/15 = . 1333. Depreciation is ($60,000 - $10,000) x . 1333 = $6,665. Calculate the depreciation rate for year five using the equation 1/15 = . 0667. Depreciation is ($60,000 - $10,000) x . 0667 = $3,335. If you add up all of the depreciation rates for the five years, it comes to 100 percent (. 333 + . 2667 + . 2 + . 1333 + . 0667 = 1). If you add up the total depreciation expense for the five years, it will total the purchase price of the vehicle less the salvage value, which is $50,000 ($16,665 + $13,335 + $10,000 + $6,665 + $3,335 = $50,000).
