What Is Equipment Depreciation? Calculating Useful Life Of Assets
It is a reality that all manufacturers face: Equipment wears over time, depreciating in value each year. Equipment depreciation is important to understand as a manufacturer because it makes a business impact on several fronts:
- For tax and accounting purposes
- For making prudent maintenance decisions
- For deciding when it is time to replace a machine
Throughout the rest of this post, we will examine these points in further detail, including why it is necessary to calculate depreciation, how to calculate equipment depreciation life, and how to use this information to make more informed decisions about maintenance.
How to Calculate Useful Life of Assets and Depreciation
There are several methods to determine the useful life of equipment. They are:
- IRS estimates: In IRS Publication 946, Appendix B, the IRS lays out standard useful life estimates for accounting and tax purposes.
- Manufacturer specs: OEMs may include useful life estimates as part of equipment documentation.
- Your experience and history: If you’ve owned a similar piece of equipment in the past, you can draw on that equipment’s useful life to estimate the useful life of other equipment.
Regardless of which method used, remember that your usage, maintenance standards and processes will also play a role in the useful life of the equipment. Useful life of equipment is an important figure to have because of the role it plays in calculating the depreciation life of assets. Depreciation is the reduction in the value of an asset year over year. It is calculated in equal annual increments over the useful life of the equipment. To calculate depreciation, you must also know the salvage value of a piece of equipment (the dollar amount for which equipment can be sold for scrap or parts at the end of its useful life). You can calculate depreciation with the following equation:
(Purchase cost – salvage value) / Useful life = Annual depreciation amount
One way of checking your math is that if you calculate the depreciation amount correctly, the asset will reach its salvage value at the end of its useful life. Depreciation is a critical need for tax and accounting purposes. It is used in two primary ways:
- Asset values should incorporate depreciation, thus reducing the listed value each year.
- Annual depreciation is a tax write-off, reducing potential tax liability for the business.
Outside of accounting, equipment depreciation can help inform maintenance decisions, as we will explore in the next section.
Equipment Depreciation and Maintenance Considerations
Depreciation and the value of assets over time should play a role in maintenance decision-making and budget allocation. Most directly, the reason is that you may not want to invest significant maintenance resources into equipment that is at or near the end of its useful life, since this equipment will not be providing benefits from a balance sheet perspective. Other maintenance points to consider with depreciation in mind include:
- If equipment is at the end of its useful life and will no longer provide a depreciation write-off, it may be advantageous to instead replace the machine to start a new depreciation cycle.
- Depreciation accounting can become quite complicated — and costly — for equipment that does not reach its useful life span. For this reason, it is a good idea to engage in good preventive and predictive maintenance practices to help ensure you get the full value of equipment.
- Preventive maintenance and predictive maintenance costs almost always show a positive return on investment when compared with the benefits of a longer equipment life span.
- Proper maintenance can extend equipment service life far beyond that of IRS estimates. Be sure to factor in your in-house processes, expectations and history when calculating depreciation in this regard.
With this information at hand, you now have an understanding of the importance of depreciation — from an accounting standpoint as well as a maintenance perspective — and can make informed decisions based on the intersection of the two.
ATS offers a range of maintenance and factory automation integration services that can help you meet and, when necessary, exceed the useful life of equipment. We also offer expertise to guide you through depreciation planning. For more information, contact us.