Updated July 14, 2023
Definition of Sum of Year Digits Method of Depreciation
The Sum of year digits method of depreciation is a type of depreciation method that means the depreciation is calculated by doing the sum of the year’s digits. It is also termed 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
The sum of year digits method of depreciation is very popular among students from a finance background. The Sum of year digits depreciation method is very effective and relevant because taking higher depreciation in the earlier years is logical. Some assets are considered less productive as time passes; therefore, every year, it is depreciated by the sum of the 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 the asset. After that, the depreciation is calculated.
Suppose any company chooses its asset to get the sum of year digits method of depreciation. In that case, they have a higher depreciation rate in the earlier years; after that, the depreciation rate decreases. By following this method of depreciation, the tax liability of the company can also be subsiding 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 asset’s life in which the Sum of year digits method of depreciation is used.
- Step 3: Now, we have to write the years in one column, the Years of digits in the second column, and the third column will be for the depreciation.
- Step 4: In the first column, all the years are written; suppose the asset’s life 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 the sum of the year’s digit.
- Step 6: In the third column, depreciation is 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 effect 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 lower 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 asset’s Residual value is $7142.86. We can also see that the depreciation rate is higher in the beginning years, and then its deprecation rate 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).
Advantages
Advantages of the sum of year’s digits method of depreciation:
- The sum of the 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.
- This depreciation method is very helpful for small businesses because the current tax is settled with the help of high depreciation on the asset.
- The sum of the year’s digits depreciation method is widely considered highly relevant for calculating depreciation.
- The Sum of Year Digits method calculates depreciation non-uniformly, which is a logical approach. The rationale behind this method is that assets naturally depreciate over time, resulting in decreased productivity.
- With the help of the Sum of year’s digits method of depreciation, we can predict the asset’s usefulness.
- This Method of 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 be 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 terms, 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. In contrast, 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. Therefore, the company will have to pay more taxes. As companies anticipate higher profits, they will experience lower deductions due to having claimed a larger portion of the deduction in earlier years. This is a practical problem with the sum of year’s digits method of depreciation. But this method is very helpful for small businesses because the immediate tax liability is managed with the help of higher deductions.
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