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. Regardless of these conceptual arguments, a company’s managers can choose between these accelerated depreciation methods for any depreciable asset.
The sum-of-the-years’ digits method is another variation on accelerated depreciation. Under this method, an asset’s depreciable base is multiplied by a declining rate. The sum of years method of depreciation is also popular with firms that are looking to write off equipment that has a high probability of becoming obsolete before the salvage value is reached. For example, a company may choose this method to depreciate assets such as computers, which may become obsolete very quickly given the rate of technological advancements in the world today.
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Companies acquire physical resources and tangible assets to enhance their business value. Examples include vehicles, machinery, cash, inventory, equipment, and land. Companies must gauge this degradation and compute asset values as it influences their operations. This assessment process is termed “depreciation.” This article delves into the specifics of the “Sum of the Year’s Digits” depreciation method. Sum-of-the-years’ digits is a method that uses an arbitrary arithmetic system to derive the annual depreciation charges.
The sum of the Year’s Digits Depreciation Model Explained:
Sum of the years’ digits depreciation is the type of depreciation method that allocates the higher cost of the fixed assets in the early year and reduces the depreciation expense in later years as time passes. The company can calculate sum of the years’ digits depreciation after determining the expected useful life of the fixed asset and the depreciable cost to use as a basis of calculation. The remaining useful life of the fixed asset is determined separately in each year of depreciation in the sum of years’ digits depreciation methods.
A company acquires these assets to increase productivity and raise the overall performance of the business. Intangible assets are amortized which is a concept similar to depreciation but the type of assets differ in both cases. In conclusion, it can be said that the SYD depreciation method is beneficial in allocating the cost of holding onto an asset over its useful life. It is important to reduce the depreciation factor’s numerator by one after every year to maintain accurate depreciation expense numbers. The initial depreciation amount is multiplied by the depreciation factor for year 1 to provide the depreciation expense in the first year. Total acquisition cost includes the purchase price, shipping costs, and any other costs undertaken to get an asset ready for use.
- From a conceptual perspective, these methods are most suited for assets that give up a greater portion of their benefits in their early years.
- Since different assets depreciate in different ways, there are other ways to calculate it.
- The sum of years method uses the expected life and adds the digits for every year to give the final depreciation expense amount.
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. Use this calculator to calculate an accelerated depreciation using the sum of years digits method. 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, it is only apt to charge a higher depreciation in the early years and decrease it in later years. This depicts the changing economic usefulness of the asset for that time.
Example and Calculation of Sum of Years’ Digits Depreciation
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The company debits depreciation expense and credits accumulated depreciation. Accumulated depreciation offsets the asset’s value, showing net asset worth in the balance sheet. An asset’s productivity is highest in its early years and gradually decreases over time.
How To Calculate Sum Of Years Digits Depreciation?
If it is left blank, Excel will assume the factor is 2 — the straight-line depreciation rate times two, which is double-declining-balance depreciation. The four depreciation methods include straight-line, declining balance, sum-of-the-years’ digits, and units of production. Sum of the years’ digits depreciation sales and use tax method involves calculating depreciation based on the sum of the number of years in an asset’s useful life. This function helps in calculating the depreciation of an asset, specifically the sum-of-years’ digits depreciation for a specified period in the lifetime of an asset.
SYD Function Importance in Finance
The only guideline is that the depreciation method should be systematic and rational, and as we noted, all of the depreciation methods discussed so far meet this requirement. Partial-year depreciation also can be calculated using the sum-of-the-years’ digits method. As a small business owner, you are well acquainted with the tax deduction for depreciation. 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.
Our example assumes ABC technologies that purchased computers for $4,000,000. Considering the useful life of the computers to be 5 years and a salvage value of $100,000. Depreciation expenses are recorded for accounting purposes and its calculation is, therefore, important to a business. Another key component to notice is that the depreciation amount for year 1 is always multiplied by the depreciation factor for each year.
The SYD function is helpful to a financial analyst when building financial models or creating a fixed asset depreciation schedule for analysis. Using the information from the example above, you would calculate the applicable depreciation percentage 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%).
For example, if the fixed asset has 5 years of useful life, the remaining useful life on the first-year calculation of depreciation is 5 while the last year or fifth year will be 1. Sum of the years’ digits depreciation uses the assumption that the benefits that the company receives from the fixed asset will go down through the passage of time. 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).
Step 3: Sum of the years’ digits depreciation formula and example
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 method is more appropriate than the more commonly-used straight-line depreciation if an asset depreciates more quickly or has greater production capacity in its earlier years than it does as it ages. The total amount of depreciation is identical no matter which depreciation method is used – the choice of depreciation method only alters the timing of depreciation recognition. 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.