Question: How Do I Calculate Depreciation? What Calculation Methods Can I Use?
Depreciation is defined as the value of an asset over its useful life. How depreciation is calculated determines how much of a depreciation deduction you can take in any one year, so it is important to understand the methods of calculating depreciation.
How Is Depreciation Calculated?
The formula for calculating annual depreciation on an asset is:
- The useful life of the asset
- Less the salvage value of the asset at the end of its useful life
- Divided by the cost of the asset.
Are There Different Ways to Calculate Depreciation?
There are several methods used to calculate depreciation. The method described above is called "straight-line" depreciation, in which the amount of of the deduction for depreciation is the same for each year of the life of the asset.
Here are the other two common ways to calculate depreciation:
Double Declining Balance
This method includes an "accelerator," so the asset depreciates more in the beginning of its useful life. This depreciation method is used with cars, for example. You know that a new car depreciates more than an older one.
Sum of the Years' Digits
In this method, the number of years in the useful life are summed. For example, if an asset had a useful life of 6 years, the digits would be added: 6+5+4+3+2+1=21. Then annual depreciation would be determined as follows:
- Year 1 = 6/21 = 28.6% times the cost (or cost less salvage)
- Year 2 = 5/21 = 23.8%
- Year 3 = 4/21 = 19%
- Year 4 = 3/21 = 14.3%
- Year 5 = 2/21 = 9.5%
- Year 6 = 1/21 = 4.8%
How Do I Figure the Useful Life and Salvage Value of an Asset?
The IRS has classifications of assets and has calculated useful life on these classes. You can find a listing of the asset classes in IRS publication 946, or your CPA can help you to find these values and to calculate depreciation on your business assets.
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