There are a number of methods a enterprise can depreciate an asset—particularly by means of straight line or accelerated modes. For an accelerated depreciation schedule, sum-of-years digits is often the commonest. Sum-of-years digits is an accelerated depreciation methodology that applies a share of depreciation based mostly on the variety of years left within the asset’s helpful life.
Firms typically use this depreciation methodology to scale back the burden of bringing on a brand new asset within the present interval and people instantly following. It’s an accounting tactic that unburdens the steadiness sheet, with out discrediting the helpful lifetime of the asset in query. Companies use this and different accelerated types of depreciation to stop steadiness sheet congestion. It may provide quick aid, however has long-term implications that corporations and buyers want to pay attention to.
What’s an Accelerated Depreciation Fee?
As an accelerated depreciation fee, sum-of-years digits permits corporations to put in writing down extra of an asset’s worth faster, tapering the total amount of depreciation over time. Whereas the asset will nonetheless find yourself absolutely depreciated on the finish of the schedule, this methodology permits a enterprise to alleviate extra of that asset from its steadiness sheet earlier. It’s a standard accounting tactic for corporations that make vital asset investments that they’ll depend on for an extended time period.
The downside of an accelerated depreciation fee like sum-of-years digits? Writing down extra of the asset’s worth in earlier years can inflate the function of asset upkeep and maintenance later within the asset’s life, when the depreciation quantity is decrease. With a straight-line depreciation methodology, a normal depreciation fee will help offset greater value of possession in later years.
Calculating Sum-of-Years Digits
To calculate asset depreciation utilizing this methodology, you first must estimate what number of serviceable years of life the enterprise will use the asset for. Then, you incrementally add these years collectively to get the depreciation fee. For instance, if the enterprise expects an asset to final six years, it could use the next calculation to get the annual depreciation fee:
1+2+3+4+5+6 = 21
On this instance, 21 is the depreciation fee. To use it, the corporate would divide the years remaining by the depreciation fee to get the full depreciable quantity for that given yr (rounding appropriately):
- Yr 1. 6/21 = 29%
- Yr 2. 5/21 = 24%
- Yr 3. 4/21 = 19%
- Yr 4. 3/21 = 14%
- Yr 5. 2/21 = 9%
- Yr 6. 1/21 = 5%
Although the quantity differs every year, the full depreciation ought to equal 100% by the top of the depreciation schedule. Therefore the identify: sum-of-years digits.
Methods Behind Sum-of-Years Digits Depreciation
The sum of years anticipated varies significantly from asset to asset. Whereas the technique for accelerated depreciation stays the identical, some belongings will function an extended or shorter schedule with differing levels of tapering depreciation. For instance, an asset with a six-year lifespan will see a 5% depreciation in its last yr. An asset with a four-year depreciation schedule will see a ten% depreciation in its last yr. Firms can use this to their benefit concerning how they account for sure belongings.
- Take one thing like a automotive, for instance. It’s well-known that automobiles are fast-depreciating belongings that lose vital worth nearly instantly. On this case, an accelerated depreciation is smart, because it paces the precise depreciation of the asset.
- Now, take into account one thing with a really lengthy serviceable life, like a chunk of development tools. The corporate will doubtless carry this asset for a decade, which might hamper its steadiness sheet if depreciated at a relentless fee. Sum-of-years digits permits the corporate to rapidly depreciate that burden, whereas nonetheless gaining worth from a crucial asset.
- Lastly, corporations want to think about their monetary accounting—particularly, the entire steadiness sheet image. Sum-of-years can carry stability to the steadiness sheet year-over-year by biking depreciation charges based mostly on when the corporate acquired the asset vs. what number of years it has left.
There’s lots of alternative in monetary management and monetary posturing in relation to sum-of-years digits as a mode of asset depreciation, Firms must determine the technique that works greatest for the asset throughout the context of the steadiness sheet.
Sum-of-Years Digits vs. Different Forms of Depreciation
Sum-of-years digits is one in every of 4 modes of asset depreciation a enterprise can use. The others embody:
Every of those strategies are allowable below Typically Accepted Accounting Rules (GAAP). The very best mode of depreciation relies on the corporate’s monetary reporting objectives and the character of the asset itself. Whereas sum-of-years digits are applicable for belongings that depreciate quickly, straight-line depreciation could also be extra relevant for belongings which have higher salvage worth. A method like items of manufacturing is best-reserved for depreciating stock. Furthermore, declining steadiness is essentially the most aggressive type of depreciation—much more so than sum-of-years digits.
Making the Most of Asset Depreciation By the Years
Each asset an organization acquires is topic to depreciation. How rapidly it data that depreciation is as much as the enterprise—and infrequently, accelerating the write-down is a good plan of action.
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Sum-of-years digits helps a enterprise mitigate the monetary impression of bringing on a major asset by offsetting its value with front-loaded depreciation. And whereas this implies recording the next value of possession within the later years of an asset’s life, it’s typically a good trade-off. The large query then turns into: what number of years is the depreciation schedule?