If you own a small business, after you purchase an asset, you will need to estimate that asset's depreciation using GAAP depreciation methods. Depreciation spreads the cost of an asset out over the life of the asset. Every year when filing small business taxes, you will need to calculate depreciation for your assets and list the depreciation of the asset as an expense on the income statement you provide to the Internal Revenue Service. To calculate depreciation, GAAP, or Generally Accepted Accounting Practices, offer several different methods. You can calculate GAAP depreciation using GAAP principles by calculating depreciation using the straight-line method, unit of production method or declining balance method of depreciation.
Most small businesses use the straight-line depreciation method. Straight-line depreciation is so popular because it is the easiest method to use. Before you calculate the depreciation of an asset, you must anticipate how many years you will use the asset and whether the asset will have any salvage value at the end of the its life. Salvage value is the amount of money that you anticipate recovering from the asset, by either sale or trade. For example, if you anticipate using a car for five years, the car will likely have value at the end of five years. Since you cannot predict the exact amount you will receive for the car after five years, you have to make an educated estimate. Next, to calculate straight-line depreciation, subtract the salvage value from the purchase price of the asset, and divide this number by the amount of useful years for the asset. This amount is the depreciation expense your small business will take each year for the use of the asset.
Units of Production Depreciation
If your small business is a manufacturing business that utilizes machines to create the product, it may make sense for you to use the units of production depreciation method. Again, like the straight-line depreciation method, you need to determine what the salvage value of the machine will be at the end of its usable life. Subtract the salvage value from the purchase value. Next, divide this number by the machine's total units of production to calculate the machine's per-unit depreciation value. Finally, multiple the number of units the machine produces each month by the per-unit depreciation. This amount is the depreciation expense your small business can take each month.
Declining Balance Depreciation
If you have an asset with a short life span, consider using the declining balance method of depreciation. By using a declining balance method of depreciation, your small business can deduct a larger amount in the beginning stage of the life of the asset. To calculate the declining balance of an asset, determine the percentage of the asset you will use each year. Then, multiple the percentage of the asset you will use each year with the asset's value. You will need to do this every year you use the asset to determine the asset's depreciation.