As time passes, every asset and piece of equipment naturally loses value through depreciation. However, this doesn’t necessarily mean they become less valuable. With the right enterprise asset management solution, you can effectively monitor the depreciation of assets and equipment. This not only helps in reducing tax liabilities but also enhances maintenance operations.
Maintenance of equipment and depreciation go hand in hand, both playing crucial roles in asset management. Regular maintenance not only prolongs the lifespan of assets but also affects their depreciation rate. By spreading out the costs over a longer period and preserving their value, proper upkeep can mitigate depreciation.
Understanding this correlation is essential for organizations, particularly in making strategic decisions about whether to repair or replace ageing equipment.
In this blog post, we’ll delve into the concept of equipment depreciation, how to calculate it, its significance in asset management, and the various advantages it offers to businesses.
What is Equipment Depreciation?
The idea behind depreciation is quite straightforward. Just think about the price you originally paid for your car. Now, try to estimate how much you could sell it for today. Chances are, the second figure is lower. That’s because, over time, most things tend to lose their value.
Of course, there are exceptions. If only you had invested in a 1968 Ford Mustang GT fastback, you could likely sell it today for more than its original price. But generally speaking, in industrial or commercial settings, the items you purchase typically depreciate over time.
Equipment depreciation specifically refers to the decrease in value your machinery experiences each year. It’s crucial to understand this concept because it provides valuable insights for better business decision-making, especially when it comes to determining whether to repair or replace equipment.
Factors Determining Equipment Depreciation Life
Determining the depreciation life of equipment involves considering three key factors:
1. Initial asset value: This refers to the original cost or purchase price of the equipment.
2. Useful life: This represents the estimated duration during which the equipment will be utilized before its value is fully depreciated. It encompasses both the operational lifespan and the period over which the equipment is expected to remain functional.
3. Salvage value: This denotes the projected residual worth of the equipment after its useful life. Once the equipment’s value depreciates to this point, it can be sold or disposed of.
In essence, equipment depreciation continues until the asset reaches its salvage value. At this stage, you have the option to sell the equipment or retire it from use entirely. The determination of an asset’s useful life can be influenced by various factors, such as manufacturer specifications, user assessments, or standardized values provided by regulatory bodies like the Internal Revenue Service.
What is the Depreciation Rate for Equipment?
There’s no set timeline for equipment depreciation—it varies depending on your industry and how crucial the equipment is to your business operations. In industries with heavy usage, some equipment might depreciate in as little as three years, while others, like storage tanks, could depreciate over 50 years.
For instance, light-duty trucks weighing under 13,000 lbs typically have a recommended four-year depreciation period, whereas equipment used in vegetable oil manufacturing might depreciate over 18 years.
Your accounting department determines the depreciation rate for your assets, adhering to your country’s tax regulations. In the U.S., the IRS offers guidelines for applying depreciation rates to equipment based on industry standards.
What is an Equipment Depreciation Schedule?
An equipment depreciation schedule serves as a record of the decline in value of a particular asset over its estimated useful lifespan. Its primary purpose is to monitor the depreciation deductions already taken.
Though there may be slight variations depending on the chosen depreciation method, most equipment depreciation schedules typically contain the following components:
Each row in the schedule represents a year.
- “Book Value at the Start” indicates the asset’s book value at the beginning of each year before any deductions.
- “Depreciation” notes the amount allocated for depreciation during that year, often referred to as the ‘depreciation expense’.
- “Book Value at the End” signifies the asset’s book value at the end of the year after subtracting the depreciation expense.
How to Calculate Equipment Depreciation
Calculating equipment depreciation is often done using the straight-line method, which involves the following formula:
(Initial Value – Salvage Value) ÷ Useful Life = Annual Equipment Depreciation
To apply this formula, subtract the salvage value from the initial value of the asset, then divide this amount by the asset’s useful life. This yields the annual depreciation amount for the equipment.
For instance, if you bought an asset for $10,000 at the start of the year, with a salvage value of $3000 and a useful life of five years, the depreciation would be:
($10,000 – $3,000) ÷ 5 years = $1,400/year
This means the equipment’s value decreases by $1,400 annually. Essentially, each year sees a consistent reduction in the equipment’s value due to depreciation until it reaches its estimated salvage value at the end of its useful lifespan. You can use this free depreciation calculator to check.
Why is it Important to Calculate Equipment Depreciation?
Businesses must calculate equipment depreciation as it helps them evaluate the current value of their equipment. On the other hand, it also helps business owners determine how much they should charge for its use and how much money they need to set aside for repairs and replacements.
Let’s discuss a manufacturing business as an example. As discussed earlier, calculating depreciation helps the business owner decide whether to buy new heavy equipment or continue leasing from another company.
Suppose a piece of office equipment costs $10,000 to buy brand new or $800 to rent for the year (this makes $9,600 over 12 months), has an expected lifespan of five years, and generates $10,000 in revenue each year during its useful life.
In this scenario, it would be a good decision for a business owner to purchase the equipment in a brand new condition, not only because it will cover the initial cost but also because it will yield profit over time, making the investment worthwhile.
What are the Benefits of Calculating Equipment Depreciation?
Calculating equipment depreciation and understanding its benefits helps you plan for the future, supports informed decisions, and enables you to make better choices about equipment purchases.
When you’re considering buying new equipment, calculating depreciation can help you evaluate whether the investment is financially viable. It can also serve as a basis for calculating your taxes in case you plan to claim any depreciation in your company’s financial statements.
Summary
Equipment depreciation is the amount of value your equipment loses every year until the point where it no longer holds any residual value. Every type of equipment depreciates, and, in most countries, you can claim that deprecation as a business expense on your taxes.
Understanding depreciation can also help you determine the total cost of ownership for your assets and decide when it’s time to replace your equipment.