Depreciation is how accounting spreads the cost of a long-lived asset over the years it is used. It turns a single large purchase into a series of smaller expenses that match the periods benefiting from the asset — and it determines the net book value your balance sheet reports.
This guide explains the concepts, walks through every major method with fully worked numbers — straight-line, declining balance, double-declining balance, sum-of-the-years'-digits and units of production — gives an overview of US MACRS and other tax regimes, and covers the practical details that cause most errors: partial years, changes in estimates, impairment and disposals.
The core concepts
- Depreciation allocates an asset's depreciable cost over its useful life. It is an allocation of cost, not a measure of market value.
- Cost is what was capitalized: purchase price plus costs directly attributable to getting the asset ready for use, such as delivery and installation.
- Salvage value (residual value) is the estimated amount you will recover at the end of the asset's useful life.
- Depreciable base = Cost − Salvage value.
- Useful life is the period (or total output) over which you expect to use the asset — which may be shorter than its physical life.
- Accumulated depreciation is the total depreciation charged to date.
- Net book value (NBV) = Cost − Accumulated depreciation − Accumulated impairment.
Depreciation starts when the asset is available for use (the in-service date), not when it is ordered or invoiced, and stops when it is fully depreciated to its salvage value, disposed of, or classified as held for sale under some frameworks.
The running example
Unless stated otherwise, the examples use one asset:
Cost $12,000; salvage value $2,000; useful life 5 years. Depreciable base = $10,000.
Straight-line
Straight-line depreciation charges an equal amount each year.
Annual depreciation = (Cost − Salvage) ÷ Useful life = $10,000 ÷ 5 = $2,000
| Year | Depreciation | Accumulated | Closing NBV |
|---|---|---|---|
| 1 | $2,000 | $2,000 | $10,000 |
| 2 | $2,000 | $4,000 | $8,000 |
| 3 | $2,000 | $6,000 | $6,000 |
| 4 | $2,000 | $8,000 | $4,000 |
| 5 | $2,000 | $10,000 | $2,000 |
Use it when the asset provides roughly equal benefit each period. It is the most common method for financial reporting because it is simple and transparent.
Declining balance (reducing balance)
Declining-balance methods apply a constant rate to the opening NBV each year, so the charge falls over time. There are two common ways to set the rate.
Fixed-rate reducing balance
The rate is chosen so that NBV reaches exactly the salvage value at the end of the useful life:
Rate = 1 − (Salvage ÷ Cost)^(1 ÷ Life) = 1 − (2,000 ÷ 12,000)^(1 ÷ 5) ≈ 30.12%
| Year | Opening NBV | Depreciation (≈30.12%) | Closing NBV |
|---|---|---|---|
| 1 | $12,000.00 | $3,614.07 | $8,385.93 |
| 2 | $8,385.93 | $2,525.61 | $5,860.31 |
| 3 | $5,860.31 | $1,764.97 | $4,095.35 |
| 4 | $4,095.35 | $1,233.41 | $2,861.94 |
| 5 | $2,861.94 | $861.94 | $2,000.00 |
Figures are calculated with the unrounded rate and rounded to cents; total depreciation is $10,000.00. The formula does not work with a salvage value of zero (the rate would be 100%), which is why multiple-of-straight-line rates are more common in practice.
Double-declining balance (DDB)
DDB uses twice the straight-line rate. Salvage value is not deducted before applying the rate; instead, depreciation stops when NBV reaches salvage value.
Straight-line rate = 1 ÷ 5 = 20%; DDB rate = 40%
| Year | Opening NBV | Calculation | Depreciation | Closing NBV |
|---|---|---|---|---|
| 1 | $12,000.00 | × 40% | $4,800.00 | $7,200.00 |
| 2 | $7,200.00 | × 40% | $2,880.00 | $4,320.00 |
| 3 | $4,320.00 | × 40% | $1,728.00 | $2,592.00 |
| 4 | $2,592.00 | × 40% = $1,036.80, capped at salvage | $592.00 | $2,000.00 |
| 5 | $2,000.00 | At salvage value | $0.00 | $2,000.00 |
Total: $4,800 + $2,880 + $1,728 + $592 = $10,000.
Switching to straight-line. When salvage value is low, DDB alone may leave a balance above salvage at the end of the life. The usual fix is to switch to straight-line on the remaining depreciable amount in the first year that straight-line gives the larger charge. Example: the same asset with salvage value $0. DDB gives $4,800, $2,880 and $1,728 in years 1–3, leaving NBV $2,592. In year 4, DDB would give $2,592 × 40% = $1,036.80, while straight-line over the remaining 2 years gives $2,592 ÷ 2 = $1,296. Straight-line is larger, so you switch: $1,296 in year 4 and $1,296 in year 5, ending at $0.
150% declining balance uses 1.5 × the straight-line rate (30% here) and front-loads less aggressively.
Use declining-balance when the asset loses value or usefulness fastest early in its life — vehicles, computers, technology.
Sum-of-the-years'-digits (SYD)
SYD is another accelerated method. Add up the digits of the useful life — for 5 years, 5 + 4 + 3 + 2 + 1 = 15 (or use n(n+1)/2 = 5 × 6 / 2 = 15). Each year's fraction is the remaining life divided by that sum, applied to the depreciable base.
| Year | Fraction | Depreciation | Closing NBV |
|---|---|---|---|
| 1 | 5/15 | $3,333.33 | $8,666.67 |
| 2 | 4/15 | $2,666.67 | $6,000.00 |
| 3 | 3/15 | $2,000.00 | $4,000.00 |
| 4 | 2/15 | $1,333.33 | $2,666.67 |
| 5 | 1/15 | $666.67 | $2,000.00 |
Total: $10,000. SYD is less aggressive than DDB in year 1 but declines in a smooth, linear way.
Units of production
Units of production ties depreciation to usage rather than time — hours operated, units produced, kilometres driven.
Rate per unit = (Cost − Salvage) ÷ Total expected units
Example: a machine costs $50,000, has salvage value $5,000 and is expected to run 90,000 hours over its life.
Rate = ($50,000 − $5,000) ÷ 90,000 = $0.50 per hour
| Year | Hours run | Depreciation | Closing NBV |
|---|---|---|---|
| 1 | 20,000 | $10,000 | $40,000 |
| 2 | 25,000 | $12,500 | $27,500 |
| 3 | 15,000 | $7,500 | $20,000 |
After 60,000 hours, accumulated depreciation is $30,000 and NBV is $20,000. The remaining 30,000 hours will depreciate the remaining $15,000 down to salvage value.
Use it when wear is driven by use rather than time and you can measure use reliably — production machinery, heavy equipment, vehicles.
Comparing the methods
Year-1 depreciation on the $12,000 asset:
| Method | Year 1 | NBV after year 2 |
|---|---|---|
| Straight-line | $2,000.00 | $8,000.00 |
| Reducing balance (≈30.12%) | $3,614.07 | $5,860.31 |
| Sum-of-the-years'-digits | $3,333.33 | $6,000.00 |
| Double-declining balance | $4,800.00 | $4,320.00 |
All four methods depreciate exactly $10,000 in total. They differ only in timing.
Tax depreciation: MACRS and other regimes
Tax authorities often prescribe their own depreciation rules, which can differ entirely from the method used in the financial statements. Many organizations therefore keep two schedules for the same asset: book and tax.
MACRS (United States) — overview
For US federal income tax, most tangible property placed in service after 1986 is depreciated under the Modified Accelerated Cost Recovery System (MACRS). Key features:
- Property classes with prescribed recovery periods — for example, 5-year property (including computers, office machinery, automobiles and light trucks) and 7-year property (including office furniture and fixtures).
- Prescribed methods — commonly 200% declining balance switching to straight-line for 3-, 5-, 7- and 10-year property.
- Conventions — usually the half-year convention (treating assets as placed in service mid-year), or mid-quarter if more than 40% of the year's depreciable basis is placed in service in the last quarter.
- Salvage value is ignored.
Because of the half-year convention, 5-year property is depreciated over six tax years. The IRS table percentages for 5-year property under the half-year convention are 20.00%, 32.00%, 19.20%, 11.52%, 11.52% and 5.76%. On a $12,000 asset:
| Tax year | Rate | Depreciation | Remaining basis |
|---|---|---|---|
| 1 | 20.00% | $2,400.00 | $9,600.00 |
| 2 | 32.00% | $3,840.00 | $5,760.00 |
| 3 | 19.20% | $2,304.00 | $3,456.00 |
| 4 | 11.52% | $1,382.40 | $2,073.60 |
| 5 | 11.52% | $1,382.40 | $691.20 |
| 6 | 5.76% | $691.20 | $0.00 |
Other provisions — such as Section 179 expensing and bonus depreciation — can accelerate deductions further, and their limits and availability change with legislation. Check current IRS guidance (Publication 946) or your tax adviser.
Other jurisdictions
- United Kingdom: accounting depreciation is not deductible for tax; instead, capital allowances apply — annual investment allowance, first-year allowances and writing-down allowances on pools of expenditure, at rates set by legislation.
- Many other countries publish prescribed tax depreciation rates or useful lives by asset class, sometimes requiring straight-line and sometimes declining balance.
Tax treatment varies by jurisdiction and changes over time. Treat the tax schedule as a separate, jurisdiction-specific calculation.
Partial periods
Assets are rarely placed in service on the first day of a financial year. Common conventions:
- Full-month: depreciate from the month placed in service (or the following month, per policy).
- Half-year: half a year's depreciation in the first and last years, regardless of the date.
- Actual days: pro-rata by days in service.
Example: the straight-line asset ($2,000 per year) is placed in service on 1 April in a January–December financial year. Full-month convention: 9 months × $2,000 ÷ 12 = $1,500 in year 1. Half-year convention: $1,000 in year 1.
Choose one convention per book and apply it consistently.
Changes in estimates
Useful lives and salvage values are estimates, and they should be reviewed. Under IFRS (IAS 16), for example, they must be reviewed at least at each financial year-end. When an estimate changes, the change is normally applied prospectively: the remaining depreciable amount is spread over the remaining life. Past years are not restated.
Example: after 2 years of straight-line, the asset's NBV is $8,000. Management now expects to use it for 4 more years (instead of 3), with salvage still $2,000. New annual depreciation = ($8,000 − $2,000) ÷ 4 = $1,500.
Impairment
If an asset's carrying amount exceeds what can be recovered from it — through damage, obsolescence or a drop in expected use — an impairment loss is recognized, and future depreciation is based on the reduced carrying amount. The impairment test differs between frameworks, so involve your accountant. See net book value explained for a worked example.
Disposals
On disposal:
- Depreciate up to the disposal date according to your convention.
- Remove cost and accumulated depreciation.
- Recognize gain or loss = proceeds − NBV at disposal.
A fully depreciated asset still in use keeps its cost and accumulated depreciation on the register until it is disposed of.
Components
Under some frameworks (IAS 16 in particular), significant parts of an asset with different useful lives — an aircraft's engines versus its airframe, a building's roof versus its structure — are depreciated separately. For most equipment registers this does not apply, but it matters for buildings and large plant.
Choosing and documenting your policy
Your fixed-asset policy should state, per asset class:
- Capitalization threshold.
- Depreciation method.
- Useful life (or range) and salvage value basis.
- Partial-period convention.
- How often estimates are reviewed.
- Book and tax treatment, if different.
Consistency is the key requirement. Accounting standards generally expect the method to reflect the pattern in which the asset's benefits are consumed and to be applied consistently from period to period.
Common errors
- Starting depreciation at invoice date instead of in-service date.
- Continuing to depreciate assets that have been disposed of or lost.
- Depreciating below salvage value with declining-balance methods.
- Mixing book and tax figures in one schedule.
- Spreadsheet formula drift after rows are copied, inserted or sorted.
- Changing methods without documenting the reason.
Try your own numbers with the free depreciation calculator.
Depreciation in Asetavo
Asetavo's depreciation module supports straight-line, reducing balance, double-declining balance, sum-of-the-years'-digits, units of production, MACRS and UK capital allowances. Cost, salvage value, useful life and method can be defaulted by category and set per asset in the register. Each asset can have a book profile, which drives NBV, and a separate tax profile, which is report-only with its own running total — so the two never overwrite each other. Compute runs are drafts that never change NBV until you post them; disposals record gain or loss; and valuation and depreciation reports export to CSV or PDF for your accounting system. Direct accounting/GL sync is on the roadmap.
Depreciation is part of the Business plan — see pricing.