Over time, the assets a company owns lose value, which is known as depreciation. As the value of these assets declines over time, the depreciated amount is recorded as an expense on the balance sheet.
Determining the monthly accumulated depreciation for an asset depends on the asset's useful lifespan as defined by the IRS, as well as which accounting method you choose to use.
Useful lifespans range from three to 20 years for personal property, 15-20 years for land improvements, and are fixed at 27.5 years for residential real estate and 39 years for business real estate. The IRS provides a about depreciation, and you can find tables of lifespans in appendix B.
The Modified Accelerated Cost Recovery System (MACRS) is the depreciation system currently used by the IRS, and allows depreciation to be calculated by either the straight-line method or the declining balance method.
With the straight-line method, you choose to depreciate your property an equal amount for each year over its useful life span. Here are the steps to calculate monthly straight-line depreciation:
First subtract the asset's salvage value from its cost, in order to determine the amount that can be depreciated.
Total depreciation = Cost - Salvage value
Next, divide this amount by the number of years in the asset's useful lifespan, which you can find in tables provided by the IRS.
Annual depreciation = Total depreciation / Useful lifespan
Finally, dividing this by 12 will tell you the monthly depreciation for the asset.
Monthly depreciation = Annual deprecation / 12
Let's say that you spend $1,500 on a computer for your office, which has a depreciation lifespan of five years, according to IRS tables. If the computer's salvage value at the end of its lifespan is estimated to be $300, this translates to total depreciation of $1,200 over the five-year period. We can calculate its monthly depreciation as follows:
Monthly depreciation = ($1,200/5) / 12 = $20
Declining balance method
The declining balance method is used to recognize the majority of an asset's depreciation early in its lifespan. There are two variations of this: the double-declining balance method and the 150% declining balance method.
Using either of these methods, the depreciation amount changes from year to year, so it's a slightly more complicated calculation than the straight-line method.
For the double-declining balance method, the following formula is used to calculate each year's depreciation amount:
2 x (Straight-line depreciation rate) x (Remaining book value)
A few notes. First, if the 150% declining balance method is used, the factor of two is replaced by 1.5. Second, the straight-line depreciation rate can be calculated by dividing the number one by the years in the useful lifespan.
Finally, the remaining book value is the original cost of the asset, minus any depreciation you've recorded so far. Putting this all together, a more general formula for the declining balance method would be:
Annual depreciation = Depreciation factor x (1/Lifespan) x Remaining book value
Of course, to convert this from annual to monthly depreciation, simply divide this result by 12.
Declining balance example
Consider the same computer we used for our straight-line example, which cost $1,500. In order to maximize your tax benefits this year, let's say that you elect to use the double-declining balance method of depreciation. In the first year, your depreciation would be:
First year decprecation = 2 x 1/5 x $1,500 = $600
On a monthly basis, this translates to $50. In the second year, the book value of the computer has fallen to $900, since you've already recorded $600 in depreciation. In the second year, the computer's depreciation is:
Second year depreciation = 2 x 1/5 x $900 = $360
So, in the second year, your monthly depreciation falls to $30. You can calculate subsequent years in the same way, with the condition that the depreciation ends once the computer's book value reaches its $300 salvage value. Over the five-year lifespan, it looks like this:
|4||$324||$24 ($300 salvage value)|