Learn how to calculate depreciable assets and what straight-line depreciation is and the steps involved in calculating it, and review an example calculation.
Everything you buy for your business has a cost attached to it, and you can deduct those costs from your taxes. Large items, such as vehicles, buildings, and equipment, are expected to last for years, so when you deduct the purchase cost from your income taxes, you do it over the course of several years. This is the idea of depreciation.
Capital Cost Allowance and the Best Time to Sell Assets
In Canada, there is an annual deduction for the cost of certain assets that you can claim on the company’s income taxes along with a variety of other deductions. Allowance rates are set by the Canada Revenue Agency (CRA).
Assume the purchased equipment cost is $20,000. In year one, the allowance is based on only half the value. Starting year two, it is based on the total depreciated value. In this example, the allowed claim is:
Year 1: $20,000 x 50% x 20% = $2,000
Year 2: ($20,000 – $2,000) x 20% = $3,600
Year 3: ($18,000 – $3,600) x 20% = $2,880
This pattern continues until the allowance reaches $0.
Situations vary, but due to the restriction in the first year, it’s probably not wise to sell your depreciable assets in year one. It’s best to sell the asset as close to year-end as possible so that you can take full advantage of the year’s allowance.
Straight Line Depreciation
Straight-line depreciation is the most common method used to calculate depreciation, and that amount is applied to your company’s asset over its useful life. The steps involved in calculating it are:
- Determine the cost of the asset.
- Determine the salvage value of the asset.
- Determine the asset’s useful life in years.
- Divide 1 by the useful life to determine the depreciation rate.
- Multiply this rate by the cost less the salvage value to get the annual depreciation.
For example, a machine is purchased for $30,000 and will work for five years. At the end of the five years, it can be sold for $8,000. The annual depreciation is:
- Depreciation rate = 1 / 5 = 20%
- Annual depreciation = 20% x ($30,000 – $8,000) = $4,400
How to Calculate Sum-of-Years Digits Depreciation
The sum-of-years digits method is a way to calculate accelerated depreciation for an asset. The method takes into account the original cost of the asset, the salvage value it can be sold for, and the useful life of the asset in years.
It takes the total number of years the asset can be depreciated, adds up those years, and uses that number as a base to weight the depreciation amounts in an accelerated way.
For example, if an asset can be depreciated over four years, the sum-of-digits method adds together 4 + 3 + 2 + 1 to get 10 years total. In the first year, the asset’s depreciation percent is 4/10 or 40%, in the second year it’s 3/10 or 30%, and so on.
As an example, assume an asset has an original cost of $100,000. It has a useful life of four years and a salvage value of $15,000. This means the depreciable value of the asset is $100,000 minus $15,000, or $85,000. The sum-of-digits depreciation schedule is as follows:
- Year 1: Starting book value is $100,000 and the depreciation amount is 40%, or $34,000. The ending book value is $66,000.
- Year 2: Starting book value is $66,000 and the depreciation amount is 30%, or $25,500. The ending book value is $40,500.
- Year 3: Starting book value is $40,500 and the depreciation amount is 20%, or $17,000. The ending book value is $23,500.
- Year 4: Starting book value is $23,500 and the depreciation amount is 10%, or $8,500. The ending book value is $15,000.
Keeping accurate records and recording transactions when they occur are the keys to making tax time a little easier. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.