When calculating depreciation, an asset’s salvage value is subtracted from its initial cost to determine total depreciation over the asset’s useful life. From there, accountants have several options to calculate each year’s depreciation.
Depreciation measures an asset’s gradual loss of value over its useful life. It measures how much of the asset’s initial value has eroded over time. For tax purposes, depreciation is an important measurement because it is frequently tax-deductible.
Accountants use several methods to depreciate assets, including the straight line basis, declining balance method and units of production method. Each method uses a different calculation to assign a dollar value to an asset’s depreciation during an accounting year.
Regardless of the method used, the first step to calculating depreciation is subtracting an asset’s salvage value from its initial cost. Salvage value is the amount for which the asset can be sold at the end of its useful life. For example, if a construction company can sell an inoperable crane for parts at a price of $5,000, that is the crane’s salvage value. If the same crane initially cost the company $50,000, then the total amount depreciated over its useful life is $45,000.
Suppose the crane has a useful life of 15 years. At this point, the company has all the information it needs to calculate each year’s depreciation. The simplest method is straight line depreciation. Using this method, depreciation is the same every year. It equals total depreciation ($45,000) divided by useful life (15 years), or $3,000 per year.