When a company pays cash for buildings, machinery, land or property, vehicles and other equipment, the purchased items are recorded as an asset since the company owns. Over time, the asset depreciates or loses value. The value that gets used up over time transfers to the asset's accumulated depreciation account and is recorded as an expense. A few different methods can be used to calculate the amount an asset depreciates each month, all of which are generally accepted accounting principles.
Estimate the asset's salvage value at the end of its useful life. You may be able to get an estimate of the salvage value from a regulatory body, such as the IRS. Alternatively, you can make an estimate based on the asset's approximate resale or scrap value at the end of its life.
Subtract the salvage value from the purchase price of the asset to determine the depreciable amount. For example, assume you purchase machinery for $14,000 that has an estimated salvage value of $3,000 with a useful life of 10 years. Subtracting $3,000 from $14,000 equals $11,000, the amount the machine depreciates over 10 years.
Divide the depreciable amount by the number of years of the asset's estimated useful life. In the previous example, dividing $11,000 by 10 years equals $1,100. This amount equals the depreciation expense for one year. Divide the result by 12 to determine the monthly depreciation expense. In this example, dividing $1,100 by 12 equals $91.67 a month.
Subtract the asset's salvage value from its book value, the price at which you purchased the asset. For example, assume you purchase equipment for $8,000 that has a useful life of five years with a salvage value of $500. Subtracting $500 from $8,000 equals $7,500, the asset's depreciable amount.
Calculate the percentage by which the asset depreciates each year. Multiply two by the fractional part of the asset's useful life representing one depreciable year. In the previous example, multiplying two by 1/5 (one year over the equipment's useful life of 5 years) equals 0.4.
Multiply the percentage by the asset's depreciable amount to determine the accumulated depreciation in the first year. For instance, multiplying the equipment's $7,500 depreciable amount by 0.4 equals $3,000, the amount the equipment depreciates in the first year. Divide the result by 12 to calculate the monthly accumulated depreciation. In this example, dividing $3,000 by 12 equals $250.
Subtract the accumulated depreciation in the first year from the asset's depreciable amount to determine its beginning book value for the next period. For example, subtracting $3,000 from $7,500 equals $4,500. Multiply this beginning book value for the second year by the percentage factor. In this example, multiplying $4,500 by 0.4 equals $1,800. Divide the result by 12 to determine the monthly accumulated depreciation amount in the second year. In this instance, dividing $1,800 by 12 equals $150.
Repeat the steps to calculate the beginning book value for the asset in subsequent years of the asset's useful life. Multiply the percentage factor by this value, and divide by 12 to determine the monthly accumulated depreciation for each year.
Add all of the digits for each year of the asset's useful life. For example, assume you purchased a copy machine for $4,000 and its estimated useful life is six years. You would add together 6, 5, 4 and each digit going back to 1. In this instance, the result equals 21.
Divide each year's digit by the sum of the useful life digits to determine the percentage by which the asset depreciates in a year. In the previous example, divide 6 by 21 to calculate 28.57 percent, which is the percentage by which the copy machine depreciates in the first year. In the second year, divide 5 by 21 to arrive at 23.81 percent, the percentage amount it depreciates in its second year. Repeat this process until you have calculated a depreciating percentage for each of the asset's useful life years.
Multiply the asset's original purchase price or depreciating amount (cost minus salvage value) by the percentage for the year you're calculating the accumulated depreciation. In the previous example, the copy machine has no salvage value. Multiplying its purchase price of $4,000 by the depreciating percentage of 28.57 in the first year equals $1,142.80, the total accumulated depreciation for the first year.
Divide the result by 12 to calculate the monthly accumulated depreciation. In this instance, dividing $1,142.80 by 12 equals 95.23, the amount of depreciation expense that accumulates monthly in the first year. Repeat the process for each of the useful life years of your asset to determine the monthly depreciation amount.
- Asset Aide: How to Calculate Depreciation
- Accounting Coach; Introduction to Depreciation; Harold Averkamp, CPA
- Accounting Coach; Accelerated Deprecation; Harold Averkamp, CPA
- Accounting Tools; What is Salvage Value?; November 2010
- Accounting Coach; What Is The Double Declining Balance Method of Depreciation?; Harold Averkamp, CPA