Definition of Sum of Year Digits Method of Depreciation
The Sum of year digits method of depreciation is a type of depreciation method which means the depreciation is being calculated by doing the sum of the year’s digits. It is also termed as accelerated depreciation. In this method, it is being assumed that the productivity of the asset will decrease as time passes. Therefore, in this case, the depreciation is calculated by taking the No. of years of the remaining life of the asset dividing by the Total of all digits of life of the asset.
Explanation
Sum of year’s digits method of depreciation is very popular among the students who belong to the finance background. The Sum of year’s digits method of depreciation is very effective and considered relevant because the logic of taking higher depreciation in the earlier years is logical. Actually, some assets are being considered less productive as time passes; therefore, every year, it is depreciated by the sum of year’s digits method. In this case, the total is calculated of all the digits of the life of the asset and then the no of years of reaming life of asset after that, the depreciation is being calculated.
If any company chooses its asset to get the sum of year digits method of depreciation, then they have a higher rate of depreciation in the earlier years, and thereafter, the rate of depreciation decreases. By following this method of depreciation the tax liability of the company can also be subside because if the depreciation is high, then the deduction will also be higher than the other years so, in the first year of the business, the sum of year’s digits method of depreciation helps to reduce the tax liability.
How to Calculate Sum of Year Digits Method of Depreciation?
- Step 1: The accountant determines the cost of the asset.
- Step 2: Determine the life of the asset in which the Sum of year digits method of depreciation is being used.
- Step 3: Now, we have to write the years in one column, Years of digits in the second column, the third column will be for the depreciation.
- Step 4: In the first column, all the years are written; suppose the life of the asset is 5 years the 1,2,….5 is written.
- Step 5: In the second column, first write the reverse of the life of assets, e.g. 5, 4…1. Now add the digits written there; this is called the sum of the year’s digit.
- Step 6: In the third column, depreciation is being calculated. The formula is (No. of years of the remaining life of asset/ Total of all digits of life of the asset).
- Step 7: After calculating the depreciation, the same given affect in the financials.
Examples of Sum of Year’s Digits Method of Depreciation
A company is considering an asset to get accelerated depreciation due to its less productivity and poor performance. The cost of that asset is $150000 and the life of the asset is 6 years. Therefore the company wants their accountant to calculate the depreciation using the sum of year’s digits method of depreciation.
Solution:
Years |
Year’s of digits
(A) |
Depreciation ($) Base
(B) |
Depreciation ($)
(C) = (B)*(A) / 21 |
Depreciation rate (D) = (C)/(B) |
1 | 6 | 150000 | 42,857.14 | 0.29 |
2 | 5 | 150000 | 35,714.29 | 0.24 |
3 | 4 | 150000 | 28,571.43 | 0.19 |
4 | 3 | 150000 | 21,428.57 | 0.14 |
5 | 2 | 150000 | 14,285.71 | 0.10 |
6 | 1 | 150000 | 7,142.86 | 0.05 |
21 |
Therefore, in this case, the Residual value of the asset is $7142.86. We can also see that the rate of depreciation is higher in the beginning years, and then its rate of deprecation is declining. This is called the sum of year’s digits depreciation method.
In this method, the depreciation is calculated by putting the formula (No. of years of the remaining life of asset/ Total of all digits of life of the asset).
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Advantages
Advantages of sum of year’s digits method of depreciation:
- Sum of year’s digits method of depreciation helps to reduce the tax liability because a larger part of the deduction is granted in the first year.
- Sum of year’s digits method of depreciation is very helpful for the small businesses because the current tax is settled with the help of high depreciation on the asset.
- Sum of year’s digits method of depreciation is considered as a very relevant method of calculating depreciation.
- In the Sum of year’s digits method of depreciation, the depreciation is not evenly distributed, which is a correct logic. The asset always tends to depreciate, and the productivity becomes lesser as the time passes, and that is why the depreciation is calculated in such a manner.
- With the help of the Sum of year’s digits method of depreciation, we can predict the usefulness of the asset.
- In Sum of year’s digits method of depreciation, the depreciation is higher in the earlier years, and later on, it gets diminished; on the other hand, the repair and maintenance cost is lower in the earlier years of the business whereas the repair and maintenance cost is higher in the subsequent years. Therefore the company will able to manage the cost of the company better.
Conclusion
The company does not frequently use the sum of year’s digits method of depreciation. In some companies, very few assets are being separately depreciated as per the sum of year’s digits method of depreciation. In general term, the sum of year’s digits method of depreciation can be a little problematic for the company because the depreciation is being captured at a higher rate at the beginning of the year, whereas in the later stage, the depreciation is lowered.
On the contrary in the later stage of the business the business gets bigger and the tax liability increases so therefore the company will have to pay more taxes and as their profits are expected to get higher the deduction will be lower because they have taken a larger portion of the deduction on the earlier years. This is a practical problem with the sum of year’s digits method of depreciation. But this method is very helpful for the small businesses because the immediate tax liability is managed with the help of higher deduction.
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