As the depreciation rate decreases over time, so does the depreciation charge. 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. The total acquisition cost refers to the total capital expenditure that the company had to undertake in order to gain possession of said assets.
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Instead, the straight-line depreciation method is more suitable if that is the case. Depreciable cost in sum of years digits depreciation can be calculated with the formula of fixed asset cost deducting its salvage value. For calculating depreciation for the asset’s first year that ends on 30 September 2021 (Year 1), we will count the remaining useful life of 4 years. For the next year of the asset’s life that ends on 30 September 2022 (Year 2), the remaining useful life will be counted as 3 years.
Steps to Calculate SYD Depreciation
Accelerated depreciation methods could also be seen as more accurate, as they assume that an asset loses a majority of its value in the first few years of its use. After all, the company should try to match the expense coming from the depreciation of the fixed asset with the benefits that it provides to the company. As mentioned, using the sum of years digits depreciation of the fixed assets will make the depreciation expense that the company charged to the income statement higher in the early year, and such expense will go down as time passes. In this case, the company should use the sum of years digits depreciation method on the fixed assets that can produce higher productivity in the early year and such productivity will gradually drop down as time passes. Sum-of-the-years’ digits is a method that uses an arbitrary arithmetic system to derive the annual depreciation charges.
Steps for calculating Depreciation
Unlike the straight-line method, which spreads the cost evenly over the asset’s life, SYD front-loads the depreciation expense, resulting in higher charges in the earlier years and lower charges in the later years. This approach is particularly useful for assets that lose value quickly or have higher utility in their initial years, such as vehicles, technology, and machinery. However, the depreciation expense in the sum of the years’ digits goes down in the linear line instead of the curve line like those in the declining balance method. After all, the calculation formula of the sum of the years’ digits depreciation is different from that of the declining balance depreciation. Similar to the double declining balance method, sum of years depreciation aims to depreciate a company’s assets at an accelerated rate. Companies may choose the SYD method as the practice will result in a larger depreciation tax shield in the first few years of the asset’s life.
Advantages of the SYD Method
- The straight-line method carries out the cost of the asset minus the salvage value, which is then divided by the useful life of the asset.
- Sum of the Years’ Digits Method involves finding the sum of all digits between zero and the number of years in the asset’s useful life.
- Therefore, it is only apt to charge a higher depreciation in the early years and decrease it in later years.
- To understand this last step, let’s change the assumptions of the earlier example.
- So we charge 3/12 of the first year’s depreciation expense ($4000) to the accounting period that ends on 31 December 2020.
Businesses must account for depreciation and there are a few ways to do it, some better suited than others depending on the specific asset. The sum-of-the-years’ digits (SYD) is an accelerated method better suited for assets that depreciate more early in their useful life since accelerated depreciation assumes higher depreciation costs in the early years. 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. Accelerated depreciation uses decreasing charge methods, including the sum-of-the-years’ digits (SYD), providing higher depreciation costs in earlier years and lower depreciation charges in later periods.
There are multiple steps involved in calculating the sum of the years’ digits. For the calculation, you will need to know the total useful life of the asset. 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 SYD method is most appropriate for assets that experience rapid obsolescence or significant early usage.
On the other hand, the sum of years’ digits can be determined by totaling the digits in every year of the fixed asset’s useful life. For example, if the fixed asset has 5 years of useful life, the sum of years’ digits can be determined to be 15 (5 + 4 + 3 + 2 + 1). Before calculating how much depreciation is electronic filing charged to each accounting period in Step 5, we first need to calculate the depreciation expense for each year of the asset life. For calculating depreciation for the first accounting period that ends on 31 December 2020 (Year 1), the remaining useful life of the delivery truck will be taken as 4 years.
To calculate depreciation charges using the sum of the years’ digits method, you’ll need to first get the depreciable base, which is the cost of the asset. 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, if you buy an asset for $100,000 and it can be sold for an estimated $10,000 at the end of its useful life, the balance subject to depreciation is $90,000, and the salvage value is $10,000. Next, calculate the applicable percentage of depreciation for each year of the asset’s life. The remaining useful life of the fixed asset is determined separately in each year of depreciation in the sum of years’ digits depreciation methods. For example, if the fixed asset has 5 years of useful life, the remaining useful life on the first-year calculation of depreciation is 5 while the last year or fifth year will be 1.
This approach requires straight-line Depreciation rates and an asset’s useful life (which is the time period over which it will be used/depreciated). Finally, this method requires management to determine the appropriate Depreciation rate. To calculate depreciation using the SYD formula, we need to input the remaining useful life of the asset at the start of the period (1 July 2021) which is 5 years. To calculate how much depreciation needs to be charged to each accounting period, we need to see the depreciation expense of each year of the asset (Step 4) that overlaps each accounting period. In sum of years, the depreciation rate is calculated based on the years of life expectancy of an asset with a little twist. The numerator will be the digit of each year, starting with the last year of life expectancy.
The machine is expected to have 8 years of useful life with a salvage value of $2,000. Due to the nature of the machine, the company ABC decides to use the sum of years’ digits depreciation method to allocate the cost of the machine over its useful life. Sum of the Years’ Digits Method involves finding the sum of all digits between zero and the number of years in the asset’s useful life. Depreciation expense under this method is calculated by multiplying the depreciable cost of an asset by the fraction of its remaining useful life and the sum of its years’ digits. This is a method that allocates higher depreciation expense in the initial years of asset use. 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.
Like the sum of the years’ digits calculated in Step 1, the depreciation base does not change over the asset’s life and therefore only needs to be calculated once. Most common methods are the straight line method or the declining balance method. In this article, we will define this calculation method, show how it works and end with an example. Try to apply your knowledge to calculate depreciation under the sum of digits method for an asset acquired mid-way during an accounting period in the multiple-choice question below. The sum-of-the-years’ digits, which is an accelerated method of calculating depreciation, can easily be calculated in Excel using the “SYD” function. This can be done when you have the asset’s cost, salvage value, and useful life.