How to Track Equipment Depreciation
Discover the importance of equipment depreciation, methods for calculation, and how it impacts your maintenance and budgeting strategies.
Equipment depreciation is an important process for any facility management team. In simple terms, equipment depreciation is a way for businesses to measure the value of assets over time. Naturally, any piece of equipment will lose its value as it ages. Equipment depreciation provides a tangible way to measure this decrease.
This can help businesses save on repair, replacement, and maintenance costs. Knowing the approximate useful life of the asset aids financial planning because your team will have a better idea of when they need to set aside part of the budget for these costs. You may also be able to claim tax deductions on depreciation.
Importance of Equipment Depreciation
Predicting your equipment’s lifetime can help you determine the value of the asset. If you plan to resell it, this will help you determine what it will be worth after a set amount of wear and tear. Financial planners may use this calculation to predict how much money your business can earn off each asset in the future. This may help you estimate if you can earn revenue off any asset with depreciation. Having this estimated amount could support your decision to resell or dispose of the asset.
Methods of Calculating Equipment Depreciation
Different methods of calculating depreciation account for the various ways in which assets may deteriorate. For example, as technology ages, it will become obsolete. Meanwhile, a desk or a chair will wear out over time due to regular use, but it doesn’t become obsolete. This difference would cause these two assets to require different depreciation calculations to account for this variance in value.
In all depreciation calculations, several terms refer to various figures that are relevant. For reference, here are what those terms mean:
- Residual value: the estimated value of an asset at the end of its useful life
- Salvage value: the estimated value of an asset at the end of its useful life if you sell it
- Market value: the value of an asset on the current market
- Book value: determined by the cost value of an item and its annual depreciation multiplied by its age
Straight-Line Depreciation Method
Straight-line depreciation is the most basic asset depreciation calculation method. It’s also the easiest to calculate. Throughout the asset’s useful life, its depreciation expense will decrease by its annual depreciation rate until it hits its salvage value.
The formula is:
Depreciation expense = (Cost – Salvage value) / Useful life
However, this expense will decrease by the asset’s annual depreciation each year. Here’s an example of what that would look like. Imagine you purchased a $10,000 asset and estimate it will have a salvage value of $5,000 after 10 years. Based on these example figures, it would look like this:
- 10,000 – 5,000 = 5,000
- 5,000/10 = 500
- 500/5,000 = 0.1
- Annual depreciation = 10%
Declining Balance Depreciation Method
With this method, the equipment loses more of its value in the first few years and less in the later years. To calculate equipment depreciation using this method, first find your straight-line depreciation rate (see above) and then apply double that rate to the equipment’s remaining value at the start of each year.
The formula looks like this:
2 x straight-line depreciation rate x book value at the beginning of the year
Returning to the example above, let’s look at an asset with a $10,000 initial value, $5,000 salvage value, 10-year life, and 10% annual depreciation.
In this case, the depreciation expense is $500 in the first year, $450 in the second year (5,000-500 x 10%), and so on for each year.
Units of Production Depreciation Method
The units of production depreciation method calculates the depreciation of an asset based on how much it produces each year. First, you estimate the total amount of work the asset will do over its entire life. Then, you calculate the yearly depreciation based on its actual usage. Usage is determined by the number of units it produces. This method also helps calculate the depreciation expenses in relation to the depreciable amount.
The formula is:
Depreciation = [(cost value – salvage value) / units produced in useful life] x number of units produced in the year
Factors Affecting Equipment Depreciation
No matter your method, extraneous factors will ultimately affect your total depreciation rate. Consider some of the following factors when you calculate equipment depreciation. How you work these factors into your calculation will vary on a case-by-case basis.
Regardless of whether you use the units of production method, usage will still affect your depreciation expense. The more you use an asset, the more wear and tear it will have. This breakdown will ultimately decrease its overall value.
Proper maintenance can significantly influence your equipment’s lifespan, performance, and overall value. As such, assets that are well-maintained will receive better depreciation rates. Plus, well-maintained equipment is less likely to experience premature wear and tear and remain functional longer. This extended lifespan can slow down your depreciation rate.
Certain market conditions, such as supply and demand, interest rates, and industry trends, can affect depreciation costs. All of these factors will also affect the current value of the asset, even at its original price. Inevitably, this will also affect its later depreciation value.
Equipment from well-known brands tends to have a higher resale value, even after several years of use. For this reason, you may be able to get a better end value on assets from trusted brand names.
Implications for Maintenance Planning
Depreciation can help determine which equipment is older and more likely to need frequent preventative maintenance or major repairs. This allows maintenance teams to prioritize which assets need more attention on a more regular basis.
Depreciation value also helps you ensure that maintenance costs align with the asset’s value. This ensures that maintenance resources are well-spent on equipment that might be better off replaced.
Budgeting and Replacement Strategies
Your depreciation schedule can provide insights into when it might be more cost-effective to replace equipment rather than continue maintaining it. Tracking asset depreciation lets you cross-reference maintenance vs. replacement costs regularly. This way, if the cost of upkeep outweighs the cost of replacement sooner than expected, you’ll know in good time.
Maintenance cost value is one of many ways to determine whether it’s more cost-effective to replace the asset. You should also consider the residual or salvage value of the asset. If the asset’s market value is higher than its book value, it might be best to replace it.
Following a proper preventative maintenance routine based on best practices and manufacturer guidelines will decrease your depreciation rate and improve its later resale value by increasing longevity. It’s important to maintain detailed documentation of this maintenance to show that your asset is in optimal condition.
It’s also important to keep an eye on market trends. Shifts in the market could increase or decrease an asset’s value. Trends may include everything from supply and demand to new technology advancements. For example, a computer that runs on a legacy operating system won’t be as valuable as one with the latest version installed.
Of course, if the asset simply won’t work, you should replace it regardless of your depreciation schedule.
Tracking Equipment Across The Lifecycle
Tracking equipment depreciation is a fundamental aspect of effective asset management. It provides valuable insights into your financial health, aids in strategic planning, and comes with tax deduction benefits.
This is because depreciation expenses reduce the total amount of company earnings on which the IRS bases taxes. The higher your depreciation expenses are, the lower your taxable income will be and the lower your total owed tax amount.
However, tracking unit depreciation isn’t just valuable for tax purposes. It’s also an important part of the asset management process. By monitoring depreciation and comparing it to the actual performance and condition of an asset, you can determine if assets are being used efficiently or depreciating faster than expected. From there, you can investigate why this might be happening and react accordingly.
Accurate depreciation tracking also helps determine the most productive and cost-effective period to use an asset. This ensures that assets are not replaced prematurely, leading to unnecessary capital expenditures or too late, which could result in increased maintenance costs or operational inefficiencies. Striking this balance is incredibly valuable in any good enterprise asset management strategy.
Trust ServiceChannel For All Your Asset Management Needs
For any fixed and depreciable assets, you can trust ServiceChannel for all your asset management needs. Our easy-to-use asset management tool makes it simple to track equipment depreciation on all your physical assets.
Quickly compare your purchase price to your depreciated value in one centralized location to simplify internal bookkeeping and clearly understand the total cost of every asset’s long-term depreciation.
Take a look at our facilities management platform to learn more about how we can help you calculate depreciation and track every asset’s entire lifecycle.