What is Depreciation On Equipment?
Depreciation On Equipment refers to spreading the cost of equipment after deducting salvage value throughout the life span of such equipment, such reduction is done usage of such equipment which reduces its resale value.
Explanation
Equipment in accounting refers to assets that are used in day-to-day business operations. Every equipment which is bought is used over certain years, which leads to a decrease in its value. Any office Equipment like devices, other tools bought at a cost cannot be sold at the same price as it has been used. Hence every year, the same or different percentage of amount is deducted from the value of an asset. This amount, which is deducted, is called as the depreciation of equipment.
How to Depreciate Equipment?
To depreciate the equipment, you must know the following:
- Cost Value: Original price or purchase price of the asset.
- Salvage Value: Salvage value is the resale value based on the market.
- Book Value: Cost value minus resale value is book value.
- A Lifetime of Equipment: Prediction of this is basis the market research, or mostly the government provides a list of life span for each vehicle or equipment.
- Method of Depreciation: This is generally decided by the management and calculated until the life span of the asset
How to Calculate Depreciation on Equipment?
Depreciation is calculated using four ways which are discussed below:
- Straight Line Method
- Written down value Method
- Units of productions Method
- Sum of the year digits Method
#1 – Straight Line Method
In this method, the same amount is deducted as depreciation. The depreciation cost is evenly spread each year until the life of the asset. The calculation of depreciation amount happens after deducting the salvage value.
#2 – Written Down Value Method
This method calculates depreciation on the cost after deducting the depreciation on each year of an asset; such value is known as Book value. This method can also be referred to as the diminishing balance method or reducing balance method.
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#3 – Units of Production Method
It is considered as the best method as it is depreciated based on the number of units machinery produced in the year than how many years machinery is used, as the production increases depreciation will also be more and vice versa.
#4 – Sum of Year Digits Method
This method is done based on the sum of the total life of an asset, this results in a higher amount of depreciation in the initial years and lesser in later years. If machinery is used to 3 years, the SOYD depreciation will be [3+2+1 = 6] first-year depreciation will be 3/6,2nd year will be 2/6, and last year will be 1/6.
Examples of Depreciation on Equipment
The following are examples of depreciation on equipment.
Example #1 – Straight Line Method (SLM)
Let’s consider the cost of equipment is $100,000, and if its life value is 3 years and if its salvage value is $40,000, the value of depreciation will be calculated as below.
- Depreciation = $100,000 – $40,000
- Book Value = $ 60,000
- Value of Depreciation = $60,000/3 = $20,000
Depreciation for each year will be $20,000 in SLM of Depreciation.
Example #2 – Sum of Years Digit Method (SOYD)
Consider the same example in the SOYD method.
- Sum of year Digits will be = 3years = 3+2+1 =6
- Depreciation for 1st yr = $60,000*3/6 = $30,000
- 2nd year = $60,000- $30,000 = $30,000*2/6 = $10,000
- 3rd year = $30,000- $ 10,000 = $ 20,000*1/6 = $3,333
In SOYD of each year, depreciation will differ, and initial depreciation will be more compared to consecutive years.
Conclusion
Depreciation is used mainly for tax purposes and accounting purposes to know the real value of the asset, the method each entity chooses varies as per their needs and purpose. If a company doesn’t depreciate, then financial reports won’t reflect the true value of the asset.
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