Planning for depreciation in fixed asset management

Several methods can be used to calculate depreciation in fixed asset management and accounting. Explore straight-line, accelerated, and other methods.

Calculating depreciation is a vital aspect of fixed asset management. It allows a business to coordinate expense recognition with the revenue supported by those expenses for a more accurate understanding of its profitability.

There are numerous strategies for planning for depreciation in fixed asset management, ranging from simple, straightforward calculations to more complex methods. The most common of these is the straight-line depreciation method, with other examples being accelerated and component depreciation.

Straight-line depreciation

Straight-line depreciation assumes a fixed asset’s usefulness will decline continually from period to period, spreading its cost evenly over the duration of its useful life.

The annual depreciation expense calculated is uniformly charged in each accounting period, reducing the asset’s book value until its salvage value is reached. The formula used for this depreciation method in fixed asset accounting is as follows: (cost – salvage value) / useful life.

For example, a business purchases a truck for £50,000 (cost) and estimates it will be in service for five years (useful life). The business also estimates the truck’s salvage value will be £5,000 at the end of the five-year period. Using the above formula, the annual depreciation expense is £9,000 [(£50,000 – £5,000) / 5].

Accelerated depreciation

Accelerated depreciation is the method used when a fixed asset is expected to have higher depreciation expenses in the first few years of its useful life, followed by lower expenses as it ages. This is due to these assets being subject to heavier use when new, most efficient, and fully functional.

The two types of accelerated depreciation methods include the double-declining balance method and the sum of the years’ digits method.

Double-declining balance method

The double-declining balance method sees the reciprocal of the asset’s useful life doubled. The resulting rate is then applied to the depreciable base (book value) for the rest of the asset’s expected lifespan.

For example, the reciprocal value of a fixed asset with a five-year useful life is 20% (1/5). To calculate depreciation, double this rate (40%) is applied to the asset’s book value. The rate remains constant, although the monetary value will decrease over time due to the rate multiplying by a smaller depreciable base in each accounting period.

Sum of the years’ digits

The sum of the years’ digits depreciation method sees all digits of the fixed asset’s expected life combined. The result is then used in periodic depreciation calculations.

Using the example of a fixed asset with a useful life of five years, the base of the sum of the digits is calculated by adding 1 + 2 + 3 + 4 + 5, equalling 15. In the first year, 5/15 of the depreciable base is deprecated. In the second year, 4/15, the third, 3/15, the fourth, 2/15, and in the fifth year, the remaining 1/15 depreciates.

Component depreciation

The component depreciation method is useful when a long-lived fixed asset comprises two or more components with significantly different useful lives. This method treats each component as a separate unit of account when calculating depreciation, allowing for more accurate financial reporting and informed decisions regarding component repair or replacement.

When using this method, a business should estimate the useful life and salvage value of each of the asset’s components. The business then uses one of several methods to calculate depreciation, such as the straight-line or sum of the years’ digits.

Software streamlines depreciation calculations

Planning for and calculating depreciation in fixed asset management is a complex, time-consuming process requiring stringent record-keeping and meticulous attention to detail, especially when done manually. FMIS fixed asset management software can revolutionise this process for businesses by automating it to ensure that asset depreciation is accurate, consistent, and regular.

By leveraging management software, businesses can ensure maximum ROI on assets and make data-driven decisions regarding replacement, upkeep, and repurchasing.