Annual Depreciation Expense = (Cost of Asset – Salvage Value)/Estimate Useful Life
Example: A machine costs $75,000 to purchase and has estimated useful life of five years, upon which time it will have an estimated salvage value of $5,000. Using the formula above, we can determine that annual depreciation will be $14,000 per year. ($75,000-$5,000)/5 Years = $14,000. The effect of the half year averaging convention is to reduce the first year depreciation by 1/2. Therefore, the 1st year’s depreciation of $14,000 will be reduced to $7,000 The simplicity of this calculation is why many prefer to use this method.
(Cost – Salvage)/Recover Period
($75,000 – $5,000)/5=$14,000 with half year convention.
Note: $14,000 in this example is normal annual depreciation. Based on the following assumptions, the allowed depreciation is:
-Tax/accounting year end of 12/31
-Annual depreciation of $14,000
-With half year convention, 1/2 or $7,000 is allowed.
Therefore:Acquired in January =$7,000/12=$583.33 per month allowedAcquired in March = $7,000/10=$700 per month allowedAcquired in August=$7,000/5=$1,400 per month allowedAcquired in December=$7,000/1=$7,000 for the month of December