Depreciation
Spreading the cost of equipment over the years it's used.
In your head, jot if needed · no calculator why?
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the idea
Equipment is used for years, so its cost is spread over those years instead of counted as an expense all at once. Each year's share is depreciation. Salvage value is what the item should be worth at the end; only the cost above it is spread.
Book value is the cost minus all the depreciation taken so far.
Depreciation is an expense, so it lowers profit and book value. It moves no cash: the cash moved whenever the equipment was paid for.
techniques
Straight-line: equal slices
- Take the salvage value off the cost.
- Divide by the years of life.
- For a month, divide the yearly amount by 12.
worked example
An oven costs $9,000, should last 4 years, and should be worth $1,000 at the end. What is straight-line depreciation per year?
- To spread: $9,000 − $1,000 = $8,000.
- Each year: $8,000 ÷ 4 = $2,000.
Answer: $2,000
Book value: what is left
- Find one year's depreciation.
- Multiply by the years that have passed.
- Take that off the cost.
worked example
A $10,000 machine with no salvage value is depreciated straight-line over 5 years. What is its book value after 2 years?
- Each year: $10,000 ÷ 5 = $2,000.
- After 2 years: $10,000 − 2 × $2,000 = $6,000.
Answer: $6,000
Double-declining balance
- The rate is 2 ÷ years of life.
- Year 1: the cost times the rate.
- Year 2: the rate times what is left after year 1.
worked example
Equipment costs $8,000 with a 4-year life and no salvage value. Using double-declining balance (twice the straight-line rate, applied to the remaining book value), what is depreciation in year 2?
- Rate: 2 ÷ 4 = 0.5, or 50%.
- Year 1: $8,000 × 0.5 = $4,000.
- Year 2: ($8,000 − $4,000) × 0.5 = $2,000.
Answer: $2,000
watch out for
- In straight-line, forgetting to take the salvage value off before dividing by the years.
- Giving the depreciation taken so far when the question asks for book value.
- Applying the double-declining rate to the original cost again in year 2.
- Assuming depreciation uses cash. It lowers profit, but the cash moved whenever the item was paid for.
practice
Straight-line per year
worked example
A packaging machine costs $34,500, is expected to last 5 years, and to be worth $3,000 at the end. What is straight-line depreciation per year?
Answer: $6,300.00
- (Cost − salvage) ÷ life = ($34,500 − $3,000) ÷ 5 = $6,300 a year.
Book value after some years
worked example
A packaging machine costs $68,000, has a salvage value of $8,000, and is depreciated straight-line over 8 years. What is its book value after 2 years?
Answer: $53,000.00
- Each year takes ($68,000 − $8,000) ÷ 8 = $7,500.
- After 2 years: $68,000 − 2 × $7,500 = $53,000.
Monthly depreciation
worked example
A $18,000 delivery e-bike with no salvage value is depreciated straight-line over 5 years. How much depreciation expense is recorded each month?
Answer: $300.00
- $18,000 ÷ (5 years × 12 months) = $18,000 ÷ 60 = $300 a month.
Double-declining balance
worked example
Equipment costs $32,000 with a 5-year life and no salvage value. Using double-declining balance (twice the straight-line rate, applied to the remaining book value), what is depreciation in year 2?
Answer: $7,680.00
- Rate = 2 ÷ 5 = 40%.
- Year 1: $32,000 × 40% = $12,800.
- Year 2: ($32,000 − $12,800) × 40% = $7,680.
Does depreciation use cash?
worked example
This year's depreciation expense on the packaging line is $11,500. By how much does it reduce the packaging line's book value this year?
Answer: $11,500.00
- Depreciation spreads the cost of the packaging line over its useful life: it cuts profit and book value by $11,500 this year.
- Depreciation itself moves no cash; the cash moved whenever the packaging line was paid for.