The same asset, using straight-line depreciation and zero salvage value, would be depreciated at $5,000 per year for five years ($25,000 ÷ 5) until the asset depreciates to zero value. The same company, with the exact same assets, would appear to be earning different amounts of profit and have assets carried at different values on the balance sheet, depending upon which depreciation method was utilized. To illustrate SYD depreciation, assume that a service business purchases equipment at a cost of $160,000. This asset is expected to have a useful life of 5 years at which time it will be sold for $10,000. This means that the total amount of depreciation will be $150,000 spread over the equipment’s useful life of 5 years.
The Sum of year digits method of depreciation is a type of depreciation method that means the depreciation is calculated by doing the sum of the year’s digits. In this method, it is being assumed that the productivity of the asset will decrease as time passes. Therefore, in this case, the depreciation is calculated by taking the No. of years of the remaining life of the asset dividing by the Total of all digits of life of the asset. On the contrary, in the later stage of the business, the business gets bigger, and the tax liability increases. As companies anticipate higher profits, they will experience lower deductions due to having claimed a larger portion of the deduction in earlier years. This is a practical problem with the sum of year’s digits method of depreciation.
Sum of the Years’: Digits Accelerated Depreciation Method
The company decides to depreciate the assets using the SYD method as it faces a fairly harsh tax environment. Also, there is a high probability that the computers will become obsolete before their useful life is up. The useful life is how long you expect the asset will be useable before it is fully depreciated. The Internal Revenue Service (IRS) offers a list of useful lives, referred to as recovery periods, by classification of asset.
The accelerated or decreasing cost allocation for asset depreciation, such as the sum-of-the-years’ digits method, better matches the cost of using an asset to the benefit the asset use provides each year over the economic life of the asset. Depreciation is a method of asset cost allocation that apportions an asset’s cost to expenses for each period expected to benefit from using the asset. Depending on the chosen cost apportionment or depreciation rate, depreciation charges can be variable, straight-lined, or accelerated over the useful life of an asset. A problem with using this or any other accelerated depreciation method is that it artificially reduces the reported profit of a business over the near term. The result is excessively low profits in the near term, followed by excessively high profits in later reporting periods. It is also more complex to calculate than straight-line depreciation, which can lead to errors in the calculation.
How to calculate sum of the years’ digits method of depreciation
This would continue until the asset was fully depreciated, having been completely expensed on the income statement and fully depreciated on the balance sheet. Many companies calculate their depreciation expense using an accounting method called accelerated depreciation. In this depreciation scenario, an asset, such as a piece of equipment, has its book value reduced on the balance sheet at a faster rate than a traditional straight-line depreciation method. Companies use a few different methods for achieving this, such as the Sum of Years’ Digits (SYD) method. The sum-of-the-years’ digits method is another variation on accelerated depreciation.
The sum of year digits method of depreciation is very popular among students from a finance background. The Sum of year digits depreciation method is very effective and relevant because taking higher depreciation in the earlier years is logical. Some assets are considered less productive as time passes; therefore, every year, it is depreciated by the sum of the year’s digits method. In this case, the total is calculated of all the digits of the life of the asset and then the no of years of reaming life of the asset.
Advantages and Disadvantages of Sum-of-the-Years’ Digits Method of Depreciation
Under the SYD method, the depreciation rate percentage for each year is calculated as the number of years in remaining asset life for the same year divided by the sum of remaining asset life every year through the asset’s life. The company does not frequently use the sum of year’s digits method of depreciation. In some companies, very few assets are being separately depreciated as per the sum of year’s digits method of depreciation. In general terms, the sum of year’s digits method of depreciation can be a little problematic for the company because the depreciation is being captured at a higher rate at the beginning of the year. Companies typically use accelerated depreciation to minimize their taxable income because it allows for greater depreciation expense deductions in the earlier years of the equipment or asset’s life.
- Some assets are considered less productive as time passes; therefore, every year, it is depreciated by the sum of the year’s digits method.
- The company does not frequently use the sum of year’s digits method of depreciation.
- Therefore the company wants their accountant to calculate the depreciation using the sum of year’s digits method of depreciation.
- Second, you’ll calculate the salvage value of the asset, which works the same for both the SYD and straight-line depreciation methods.
For example, suppose that a company purchases equipment on 1 October of the current year. The exception is that the calculations needed in sum-of-the-years’ digits are slightly more complex.
What is ‘inc.’ in a company name?
The total acquisition cost refers to the total capital expenditure that the company had to undertake in order to gain possession of said assets. Using the information from the example above, you would calculate the applicable depreciation percentage for each depreciable year. In the first year, the asset value subject to depreciation would be expensed 5/15 in value (33.33%). In the second year, the asset value subject to depreciation would be expensed 4/15 (26.67%). In the third year, the asset value subject to depreciation would be expensed 3/15 (20%).
Repair and Maintenance Costs
Sum-of-the-years’ digits is a method that uses an arbitrary arithmetic system to derive the annual depreciation charges. As an asset gets older, repair and maintenance costs are to rise as the asset needs repairs more often; again, consider an automobile as an example. The benefit of using an asset will decline as the asset gets older, meaning an asset provides greater service value in earlier years. Therefore, charging higher depreciation costs early on and decreasing depreciation charges in later years reflects the reality of an asset’s changing economic usefulness over time. The sum of years depreciation method works by depreciating the asset’s depreciable amount by a depreciation factor unique to each year. The depreciable amount is equal to the asset’s total acquisition cost less the asset’s salvage value.
Definition of the Sum-of-the-Years’-Digits Depreciation
The fourth year depreciation will be $20,000 (2/15 of $150,000), and the fifth year will be $10,000 (1/15 of $150,000). Remember that the total amount of depreciation during this asset’s useful life should be $150,000. After you take depreciation in the fifth year, your asset will be worth its salvage value—$30,000.