Sum of Years Digits Method of Assets Depreciation Pros, Cons

Let’s go through an example using the four methods of depreciation described so far. Assume that our company has an asset with an initial cost of $50,000, a salvage value of $10,000, and a useful life of five years and 3,000 units, as shown in the screenshot below. Our job is to create a depreciation schedule for the asset using all four types of depreciation.

• However, in reality, companies do not think about the service benefit patterns when selecting a depreciation method.
• To demonstrate how this fraction is worked out, suppose that an asset has a 5-year life.
• The primary advantage of this method is that it provides a more accurate trend for Depreciation expenses.
• Use of the method can have an indirect impact on cash flows, since accelerated depreciation can reduce the amount of taxable income, thereby deferring income tax payments into later periods.

Thus, it means that depreciation rate is charged on the reducing balance of the asset. This asset is the one reflected in the books of accounts at the beginning of an accounting period.So, the book value of the asset is written down so as to to reduce it to its residual value. Each number is then divided by this yield to maturity vs coupon rate sum to derive the percentage depreciation for each year. This approach calculates the annual depreciation rate by considering the remaining years of useful life divided by the sum of the remaining years in each subsequent year. There are multiple steps involved in calculating the sum of the years’ digits.

This 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. Depreciation accounts for decreases in the value of a company’s assets over time. In the United States, accountants must adhere to generally accepted accounting principles (GAAP) in calculating and reporting depreciation on financial statements. GAAP is a set of rules that includes the details, complexities, and legalities of business and corporate accounting. GAAP guidelines highlight several separate, allowable methods of depreciation that accounting professionals may use. The DDB function is used for calculating double-declining-balance depreciation (or some other factor of declining-balance depreciation) and contains five arguments.

Step 2: Find the Sum of Useful Life

As an asset gets older, repair and maintenance costs are to rise as the asset needs repairs more often; again, consider an automobile as an example. Accelerated depreciation allows for the likelihood of assets to decline over time, and also to require higher repair and maintenance costs in later years than when first purchased. The sum of years’ method matches the cost of utilizing an asset and the overall utility of the asset across the economic or useful life of the asset. A major benefit of using this method is that it considers the fact that the asset performance will decline over the years; i.e. the asset is more productive in the early years.

Therefore, the earnings may be distorted if the year’s sum is not a method of accelerated depreciation. The sum of years digit (SYD depreciation) is an accelerated depreciation for calculating an asset. This method takes the asset’s useful life and adds it together to give the final depreciation expense amount. These eight depreciation methods are discussed in two sections, each with an accompanying video.

Double Declining Balance Method

It is the estimated net realizable value of an asset at the end of its useful life. This value is determined as a result of the difference between the sale price and the expenses necessary to dispose of an asset. So, as an asset moves towards the end of its useful life, the benefit gained out of such an asset declines. That is to say, highest amount of depreciation is allocated in the first year since no amount of capital has been recovered till then. Accordingly, least amount of depreciation should be charged in the last year as major portion of capital invested has been recovered.

The sum-of-the-years’-digits method (SYD) accelerates depreciation as well but less aggressively than the declining balance method. Annual depreciation is derived using the total of the number of years of the asset’s useful life. The SYD depreciation equation is more appropriate than the straight-line calculation if an asset loses value more quickly, or has a greater production capacity, during its earlier years. 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. 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.

It must be noted that the final depreciation expense equals the salvage value of the asset. The sum of the years method assumes that the productivity of the asset is the highest in the initial years and goes on decreasing in the subsequent years. Depreciation is carried out for tangible assets which are the physical assets.

How to calculate sum of the years’ digits method of depreciation

It is similar to the declining balance depreciation in which the depreciation expense in the sum of the years’ digits method will go down as time passes making the last depreciation expense the smallest. The total amount of depreciation taken over the entire life of the asset should equal the depreciable cost (cost minus salvage value). You can manually adjust the depreciation expense taken to equal the depreciable cost, or you can include additional formulas to make sure that the total depreciation equals the depreciable cost. If you are interested, these additional formulas are included in the Excel workbook and produce the results shown in the screenshot below. There are four allowable methods for calculating depreciation, and which one a company chooses to use depends on that company’s specific circumstances. Small businesses looking for the easiest approach might choose straight-line depreciation, which simply calculates the projected average yearly depreciation of an asset over its lifespan.

How to use the SYD Function in Excel?

In the third year, the asset value subject to depreciation would be expensed 3/15 (20%). This would continue until the asset was fully depreciated, having been completely expensed on the income statement and fully depreciated on the balance sheet. It calculates depreciation expenses based on the number of years of the useful life of an asset. 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. 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.

Finally, a depreciation schedule can be created as we have all the components for calculating the depreciation expense in Year 1. Therefore, it can be said that SYD provides a realistic depreciation expense since the method acknowledges that assets are typically more productive and valuable in their early years. Life– This is the useful life of the asset or the number of periods for which the asset will be depreciated. Aligns asset cost with yearly usage across its useful life, particularly beneficial for assets most productive in early years. We were assuming a 5-year useful life and a salvage value of $100,000, with $200,000 in transportation expenses.

Repair and Maintenance Charges

In addition to the tax benefit depreciation provides, it also allows you to track and decrease the value of your assets over their useful life. When you depreciate an asset, you recognize an expense that represents the value of the asset used during the period. Depreciation is calculated using a straight line technique in which the value of a fixed asset is diminished during its useful life. Companies choose this method because it provides a bigger depreciation tax shield in the first few years of an asset’s life. A company estimates an asset’s useful life and salvage value (scrap value) at the end of its life. Depreciation determined by this method must be expensed in each year of the asset’s estimated lifespan.