When your company has a tangible asset, whether it’s a property, equipment, or even furniture, depreciation is a great way to implement on your accounting to allocate the cost of each asset over its useful life. It is especially useful if you recently started your business and want to avoid your company getting in the red in the first accounting year.
In this post, we’re going to share some in-depth information about depreciation, why it can be beneficial for your company’s accounting section, how to calculate depreciation for all of your company’s tangible assets, and the best way to do it.
Try our online invoicing software for free
Accept online payments with ease
Keep track of who's paid you
Start sending invoices
So, is it necessary to depreciate your business assets? Let’s find out!
What is depreciation?
When you start a new business, you may not be familiar with many accounting terms as an entrepreneur. However, as a business owner, you must be aware of the essence of running your own business as well: generating a profit and keeping your finances stable to let your business grow.
The first year of your company is essential, as you’re more likely to spend on inventories than anything else. Depreciation will represent the value of an asset as long as it’s useful in their business. By implementing it in your accounting, you allow your company to earn income from the assets by including them on your payables over a certain number of years.
Before calculating the depreciation of your tangible assets in accounting, there are a few things you need to consider for each item. These include:
- The cost of the asset, as you also need to calculate the depreciable cost of each item over time.
- The salvage value of the asset defines the estimated amount of money that your company expects to gain at the end of the asset’s useful life for your business.
- The estimated useful life of the asset is calculated by how long your company plans to use the item, whether it’s within months, years, or the number of units produced.
- The obsolescence of the asset is needed to determine when there is a possibility that the asset may no longer exist in a certain period of time.
Why You Need to Calculate Depreciation
Now that you know how depreciation works, it’s time to understand why depreciation of assets can benefit you as a business owner. Not only does it allow your company to deduct the asset value from your income tax, it can also provide monetary benefits in the case of economic loss.
While the term amortization is commonly used to calculate the depreciating value of intangible assets like branding, copyright, and patents, we use depreciation for tangible ones.
Before deciding whether asset depreciation is the right method for your business, there are several considerations to ensure that your business is qualified for asset depreciation, including:
- The assets must be owned by you or your company.
- The assets must be used for your company’s productivity, which means that they exist to support you in running your business.
- You can determine the useful life of the assets, ideally for over a year.
It is also important to note that not all assets can be depreciated. For instance, you cannot depreciate assets that are not categorized as income-producing items or assets that increase in value over time. Some of these assets include:
- Stocks and bonds investment
- Buildings if you don’t rent it to others for income
- Any item that you don’t regularly use
Once you determine whether you can depreciate your assets, it’s time to get to the next stage: finding the best to calculate depreciation for your company’s tangible assets.
How to Calculate Depreciation
In essence, once you determine the necessary items to calculate your asset depreciation, the next step is to find the best method to start calculating it to include in your bookkeeping process.
You can use a few methods to calculate your asset depreciation. In this section, we will go through some depreciation methods you can apply to your accounting.
It is probably the easiest way to calculate depreciation and the most common method companies use to calculate their assets. The best way to use the straight-line depreciation method is when your asset’s value steadily decreases over time.
To get the number of your asset depreciation using a straight-line method, you will need to determine at least three items: the price of the asset when you purchased it, the approximate salvage value, and the estimated useful life of the asset.
When you use the straight-line method to calculate depreciation annually, you will divide the depreciable amount by the useful life of the asset.
For instance, if you purchase a PC for $2,500, the salvage value when it’s no longer useful for you would be around $500, with an approximate useful life of 5 years. Based on these assumptions, this is what you get to calculate its depreciation:
The Declining Balance method to calculate depreciation is most suitable for assets that will likely require more repairs and maintenance as time goes by. This method is also appropriate for calculating depreciation for assets with an obsolescence tendency.
Assuming that the asset has the most value in the earlier year, the declining method will have a larger depreciation during the first couple of years since the company purchased it. To calculate this using declining balance method, you need three items to get the formula: the current book value when the depreciation is calculated, the salvage value, the useful lime of the asset, as well as the depreciation rate.
Referring to the number you get from the straight-line method in the previous section, the depreciation rate of the PC will be around 16% ($400 out of $2,500 in the original price when you purchased it).
When using the declining balance method, the formula will be as the following:
Sum-of-the-Years’ Digits (SYD)
The third method for calculating depreciation for your company’s tangible assets is the sum-of-the-years’ digits method. By using this method, you need to sum up the total digits of numbers taken from the estimated useful time of your asset.
Most suitable to calculate asset depreciation, especially for those that lose most of the value at the beginning of their useful life. If we refer to the first example, with a useful life of 5 years, the sum-of-the-years calculated will be 1+2+3+4+5. Based on the latter, we will get 15 as the variable number used in the formula to calculate the asset depreciation.
Using it as a reference, this is the number we’ll get using the SYD method to calculate the depreciated value of the asset.
Units of Production
Another way to calculate your asset depreciation is by calculating the estimate of total production that the asset produces over its useful life. For instance, if you have a cleaning company, you can calculate the depreciation of your cleaning equipment by calculating how many cleaning projects you can produce per period and how much the estimate of revenue you can generate periodically.
Accounting can be challenging for a small business owner, especially if you don’t have any background in the field. Calculating your asset depreciation is only one of the many things you need to consider while doing your business’s bookkeeping.
While there are so many accounting tips you can find online, when it comes to tax and money, you may want to be more vigilant and get to know the basics first to make sure that you’re doing the right thing with your income and expenses.
InvoiceBerry, apart from providing an invoicing system that can streamline your invoicing process, also offers this mini accounting course that you can sign up for free to tackle your accounting problems when you run your business.
So, are you ready to take the next step in the accounting side of your business?