Sum of Years Digits Method of Assets Depreciation Pros, Cons

Accelerated depreciation is also appropriate for assets that have higher repair expenses in later years. To demonstrate how this fraction is worked out, suppose that an asset has a 5-year life. In the first year, the rate is a fraction that has a numerator of 5, the number of years remaining at the beginning of the year.

For example, if an asset has a useful life of 5 years, the sum of its years’ digits will equal 15 (1 + 2 + 3 + 4 + 5). Once a company decides on a depreciation method it typically has to stick with that depreciation method going forward for that particular asset. It starts with the value n in the first year and decreases by 1 each year until it equals 1 in the final year of the asset’s estimated service life. Furthermore, management can choose straight-line depreciation for financial reporting purposes and a special form of accelerated depreciation for tax purposes. This rate is a fraction, in which the numerator is the number of years remaining in the asset’s life at the beginning of the year and the denominator is the sum of the digits of the asset’s useful life. The asset has 3 years useful life at the end of which it is not expected to have any salvage value.

Adjusting Journal Entries Accounting Student Guide

If an asset is acquired on the first day of an accounting period or if it is the accounting policy to charge a full year’s depreciation in the year the asset is received, this will be the last step of the SYD depreciation calculation. As with similar depreciation methods, in the last year we ignore the formula and depreciate only to the salvage value of the asset. The simplest and most common method of depreciation is the straight-line basis method of depreciation.

Note how the depreciation factor works backward, starting with the largest value (Year 4) before incrementally dropping in each period thereafter. The economic useful life of the industrial components is merely 4 years because of the rapid “wear-and-tear” attributable to the use-case. Accountingo.org aims to provide the best accounting and finance education for students, professionals, teachers, and business owners. Someone on our team will connect you with a financial professional in our network holding the correct designation and expertise.

Sum of the years’ digits depreciation method involves calculating depreciation based on the sum of the number of years in an asset’s useful life. Under the sum of the years’ digits method (SYD), the depreciation expense recognized in each period is the depreciation factor multiplied by the depreciable basis. The depreciable basis is calculated by subtracting the salvage value assumption from the purchase cost (Capex), which refers to the residual value of the fixed asset at the end of the fixed asset’s useful life.

The sum-of-the-years’ digits, which is an accelerated method of calculating depreciation, can easily be calculated in Excel using the «SYD» function. 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. The accelerated or decreasing cost allocation for asset depreciation, such as the sum-of-the-years’ digits method, better matches the cost of using an asset to the benefit the asset use provides each year over the economic life of the asset. Many companies calculate their depreciation expense using an accounting method called accelerated depreciation. In this depreciation scenario, an asset, such as a piece of equipment, has its book value reduced on the balance sheet at a faster rate than a traditional straight-line depreciation method.

Using the information from the example above, you would calculate the applicable depreciation percentage dividends in arrears for each depreciable year. In the first year, the asset value subject to depreciation would be expensed 5/15 in value (33.33%). In the second year, the asset value subject to depreciation would be expensed 4/15 (26.67%). In the third year, the asset value subject to depreciation would be expensed 3/15 (20%).

Sum of the Years’ Digits Depreciation Formula

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. Using the depreciation formula, we can calculate the amount of depreciation for each xero hour 2021 year of the asset’s life using the values calculated in Steps 1 to 3. For example, to calculate the depreciation of an asset with a useful life of 3 years, we will count the remaining useful life of 3 years in year 1, 2 years in year 2, and 1 year in year 3.

Step 2 of 3

1. Hence, for an asset that has a useful life of 4 years, the un-depreciated useful life to be used in calculating depreciation shall be 4 years in the first year of depreciation, 3 years in the second year and so on.
2. Un-depreciated useful life is equal to the number of years in the asset’s useful life that have not yet been subjected to depreciation.
3. Therefore, the depreciation expense for the second accounting period is equal to 9/12 ✕ $4000 plus 3/12 ✕ $3000.
4. A problem with using this or any other accelerated depreciation method is that it artificially reduces the reported profit of a business over the near term.

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. 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.

In other words, the difference is in the timing of when the same total amount of depreciation will be reported. Where an entity has a policy of calculating depreciation on full years basis, sum of the years’ digits depreciation can be calculated as above. Sum of the years’ digits depreciation method, like reducing balance method, is a type of accelerated depreciation technique that allocates higher depreciation expense in the earlier years of an asset’s useful life. The formula to calculate the sum of the years’ digits depreciation divides the remaining useful life by the sum of the years’ digits of the fixed asset (PP&E), which is then multiplied by the depreciable basis. The sum of the years’ digits method of depreciation, or “SYD”, reduces the book value of a fixed asset (PP&E) at a front-loaded, accelerated depreciation rate.

Remember that the total amount of depreciation during this asset’s useful life should be $150,000. 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. The same asset, using straight-line depreciation and zero salvage value, would be depreciated at $5,000 per year for five years ($25,000 ÷ 5) until the asset depreciates to zero value. The same company, with the exact same assets, would appear to be earning different amounts of profit and have assets carried at different values on the balance sheet, depending upon which depreciation method was utilized. Un-depreciated useful life is equal to the number of years in the asset’s useful life that have not yet been subjected to depreciation. The depreciation factor – the ratio between the remaining useful life and sum of the years’ digits – is 4/10, 3/10, 2/10, and 1/10 from Year 1 to Year 4, respectively.

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. The implicit assumption of the sum of the years’ digits depreciation method is that the fixed asset (PP&E) is more productive and provides more near-term value in the periods immediately post-purchase. We only need to calculate this value one time in an asset’s life when we estimate its depreciation for the first time. We will use the same value to calculate the depreciation expense of the future accounting periods. There are a multitude of depreciation methods – such as the straight-line method, double declining balance (DDB), and units of production method – but the sum of the years’ digits is categorized as a form of accelerated deprecation. Based on the depreciation expense calculated for each year of the asset’s life in Step 4, calculate the depreciation amount that needs to be charged for each accounting period.

Under the sum of the years’ digits method, the depreciation rate is higher in the earlier periods of the fixed asset’s economic useful life relative to that in the latter periods. The sum-of-the-years’-digits depreciation (SYD depreciation) is one method for calculating accelerated depreciation. However, the total amount of depreciation over an asset’s useful life should be the same regardless of which depreciation method is used.

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. Use this calculator to calculate an accelerated depreciation using the sum of years digits method. For example, in the first accounting period that ends on 31 December 2020, only 3 months out of the first year of the asset overlaps. So we charge 3/12 of the first year’s depreciation expense ($4000) to the accounting period that ends on 31 December 2020.