Hey there welcome back to Accounting Stuff
I'm James and in this video you'll find out how to calculate depreciation
using the Sum of the Year’s Digits method so let's get cracking!
Depreciation is the process of reducing the book value of a
tangible fixed asset due to use wear-and-tear
the passing of time or obsolescence
Sum of the Year’s Digits depreciation is an accelerated variable cost
depreciation method where the expense is higher in early years
If you saw my double declining balance video last week
you might notice that this description hasn't changed
That's because both of these are accelerated variable cost
depreciation methods but the calculation behind
each one is different as you'll soon see
Time for an example you know that big empty field you own
the one behind your house that catches all the sun
Anyways one day you decide to turn it into a solar farm
A solar panel is a tangible fixed asset it's tangible because you can touch it
and it's fixed because you plan to use it for a long time
Each panel cost you $25,000 and is expected to last
for five years By the way did I mention
that you're also really really rich After that their value will drop
right down to $5,000 Let's depreciate one of these panels
using the Sum of the Year’s Digits method Step 1
Write down what you know Your asset is a solar panel and
we’ll depreciate it using the Sum of the Year’s Digits method
Asset cost is what you initially paid for it
$25,000 It's residual value at the end of
its useful life is $5,000 and it's useful life is five years
We’ll leave depreciation rate and depreciable cost blank for now
because we'll work these out in step 3 But first Step 2
Build a depreciation schedule The depreciation schedule is a table
and for the Sum of the Year’s Digits method it has six columns
So that's one more than we used for the straight-line and
double declining balance methods We have year
opening book value depreciation rate
depreciation expense accumulated
depreciation and closing book value
Can you guess which one's new?
Its depreciation rate we're going to give depreciation rate
its own column because this is going to change each year
Step 3 Calculate the depreciation rate
depreciation expense accumulated depreciation and
book values for each period Time to fill this sucker out
We'll begin with the first accounting period that's year 1
You're opening book value is the carrying amount of your solar panel
at the start of the year This is your first accounting period
so that's going to match your asset cost of $25,000
Now let's work out your Sum of the Year’s Digits
depreciation rate for year 1 By the way we often shorten
Sum of the Year’s Digits to just SYD It's just quicker to say I guess…
You're SYD depreciation rate is equal to the remaining useful life
of your asset divided by the Sum of the Year’s Digits
Your remaining useful life is exactly what it sounds like
How many useful years you have left on your solar panel
We said at the start that it has a useful life of five years
so in year one its remaining useful life is also five years
but be careful because this top line changes each period
Now the bottom line is called the Sum of the Year’s Digits
and it doesn't change we only have to work it out once
There are two ways to do that and I'll show you both
The long way is more intuitive we are after the
Sum of the Year’s Digits so all we need to do is add up
each year of your solar panel's 5 year useful life
so five plus four plus three plus two plus one which is 15 years
Seriously that's all there is to it Now for the short way
mathematicians call a series like this the sum of an arithmetic series
and they've derived a short formula that'll give us the answer every time
Sum of the Year’s Digits is equal to useful life multiplied by useful life plus
one divided by two
So let's test it out five years multiplied by six years
divided by two gives us 15 years I have included this in
my depreciation sheet so if you’d like to support this channel
and keep a handy little reminder of the formula then you can
buy a copy of it on my website I'll link to it down in the description
Choose your method it doesn't matter which
and let's move on Your depreciation rate for year one
is five years which changes each year divided by 15 years which
remains the same this gives us 1/3 or 33.33%
Now let's calculate your depreciation expense
This is your SYD depreciation rate multiplied by your depreciable cost
It represents the amount of your solar panel that you’ll write off
as an expense to your income statement during the year
Keep in mind that the Sum of the Year’s Digits method is an
accelerated variable cost depreciation method where the
depreciation expense is higher in early years
We'll come back to this graph in a moment
We've already worked out your depreciation rate for year one
it’s 33.33%.
Your depreciable cost is the difference between your asset cost
and residual value $25,000 minus $5,000 which is $20,000
this is the chunk of your solar panel's book value which we'll depreciate
over its useful life One third of $20,000 is $6,667
your solar panel’s depreciation expense in year one
Accumulated depreciation is the sum of all depreciation expenses incurred to date
In year one it’s the same as your depreciation expense
Closing book value is the carrying amount of your solar panel
at the end of the year this is the net asset amount that you're holding in
your balance sheet We can work it out by taking
your opening book value of $25,000 minus your depreciation expense of $6,667
which is $18,333 Now we'll repeat the process
for the following period Your closing book value in year one
becomes your opening book value in year two
Your depreciation rate is the remaining useful life of your asset
divided by the sum of the years digits This is year two so your remaining
useful life has reduced to 4 years Sum of the Year’s Digits doesn't change
it's still 15 years so 4 years divided by 15 years gives you an
SYD depreciation rate of 26.67% Your depreciation expense is your
SYD depreciation rate multiplied by your depreciable cost
so that's 26.67% multiplied by $20,000 which is $5,333
Accumulated depreciation is $12,000 and your closing book value is
$18,333 - $5,333 which is $13,000 Here's the completed
depreciation schedule for the whole of your solar panels useful life
Your asset cost at the start is $25,000 and we've written off
a depreciation expense to your income statement each year after
five years the closing book value of your solar panel has decreased
to $5,000 which is exactly the same as the residual value that we
picked at the start This is just a handy little check
to make sure that we've done things right Let's have another look
at all of this on the graph This is your solar panel’s
book value over time Your asset cost at the beginning
is $25,000 and it's residual value at the end is $5,000
Your depreciable cost is the difference between the two
The solar panel has a useful life of five years and its
remaining useful life decreases over time
The depreciation expense is variable because it changes each year
and it’s accelerated because it's higher in early years
But not all variable depreciation methods are accelerated as you'll see
in the next video where I'll cover the units of production method
Make sure you subscribe if you'd like to watch that
You can find all of my depreciation videos on the depreciation playlist and
if you'd like a copy of my cheat sheet then it's right here
Til next time