How to Determine Your Office Furniture Depreciation
Published August 18, 2020
For non-accountants, calculating your office furniture depreciation can be confusing. So some businesses opt to do it the simplest way: by dividing the furniture’s purchase cost with its useful life. For example, if they bought the office furniture at $100 and is expected to be used within the next 5 years, the yearly depreciation is $20.
Unfortunately, this isn’t always applicable.
You see, all assets including office furniture depreciate every year. But not at the same rate. Some depreciate faster than others. So it’s essential to understand how each furniture depreciates to come up with a more accurate depreciation amount.
But before we dig deeper, let’s first refresh our knowledge on depreciation.
What is Depreciation?
Depreciation is a way of amortizing the value of an asset over its useful life.
For example, you’re expecting a cabinet you just purchased to be useful for the next ten years. Rather than deducting the entire amount you paid for it as an expense in the year it was bought, you divide it into ten years.
Depreciation is based on the Matching Principle in accounting. The principle states that income and expenses should be recognized in the year they are earned and spent regardless of when they are paid.
Since you’ll be able to use that cabinet for 10 years, it means that it will help you earn an income within those years. Therefore, you need to divide the expense of the cabinet on the years that you’re earning income from it. By doing this, you’re making sure that your income and expenses will match.
On your part as a business owner, depreciation will also help you lower your taxes. That’s because depreciation is considered an expense and thus deductible from your taxable income. Though it’s tempting to declare a large depreciation, the IRS puts a cap on how much depreciation you can claim in a year. But more of that later.
Definition of Terms
To better understand the concept of depreciation, let’s define the terms often associated with it.
In accounting, asset simply means a property that you expect to be useful beyond the fiscal period. This includes land, building, and office equipment among others.
Estimated Useful Life
When you say that an asset has an estimated useful life of five years, it means that you expect to use it for 5 years. Remember this is just an estimate. Some assets exceed their useful life while others may become useless even before they become fully depreciated. Either way, it’s okay. You can adjust the depreciation as you deem fit or maintain the asset in your books even if it’s fully depreciated.
Salvage value basically just means the asset’s scrap value. It’s how much you expect to sell it when you’re not using it anymore.
How to Calculate Depreciation
As mentioned, assets like office furniture depreciate at varying rates. This is why there are several ways to calculate depreciation. Here are some of them:
Straight Line Depreciation
This is the easiest and most simple way to calculate depreciation. You just take the asset’s purchase price and deduct its salvage value. Then divide it by the asset’s estimated useful life.
The formula would look like this:
Depreciation = (purchase price – salvage value)/estimated useful life
You bought a cabinet for $1,000 and you expect to use it for the next 10 years. It’s estimated scrap value is $200.
Depreciation =($1,000 (purchase price) – $200 (salvage value)) / 10 years (useful life)
Depreciation = $800/10
Depreciation = $80
Your annual depreciation is $80. This is a uniform annual amount that you will recognize as expense in the next ten years.
Double Declining Balance Depreciation
This depreciation method is appropriate for assets that are less useful over time. For example, you bought a computer set. You expect to use it in the next 10 years but you know that after only 3 years, a new model will come out. So your employees will probably use that computer much less frequently.
The logic behind the double-declining balance is to depreciate an asset in the years when it’s more useful. As a business owner, you’ll also be able to recover the cost of the item much faster.
Under this method, the depreciation amount in the first year you depreciated the asset is doubled. Then in the subsequent years, the asset’s book value is used instead of the purchase price.
The formula would look like this:
Depreciation = (2 x depreciation rate) x book value at the beginning of the year
To get the depreciation rate, just divide 1 by the asset’s useful life. So if the asset has a useful life of five years, the depreciation rate is 0.20 or 20%.
To illustrate, let’s take our cabinet example again: $1,000 purchase price with 10 years of estimated useful life. Since it is depreciated for 10 years, the depreciation rate would be 10%.
Depreciation = (2 x 10%) x $1,000
Depreciation = 20% x $1,000
Depreciation = 200
After year 1, your book value for the cabinet will only be at $800 ($1,000 – $200). This is what you will use for next year’s computation.
Depreciation = (2 x 10%) x $800
Depreciation = 20% x $800
Depreciation = 160
This goes on until the asset is fully depreciated.
Sum of the Year’s Digit Depreciation (SYD)
Just like the double-declining balance method, SYD lets you depreciate an asset more in the first year than the succeeding years. Albeit with a slightly more even distribution.
Under this, you will have to divide the remaining lifespan of the asset over the sum of the year’s digit. Then multiply it by the difference of the asset’s purchase price and its salvage value.
So the formula would look like this:
Depreciation = (remaining lifespan / SYD) x (purchase price – salvage value)
To calculate for SYD, just add up all the digits in the asset’s useful life. So if an asset has a useful life of five years, the SYD will be 15 (1 + 2 + 3 + 4 + 5).
Using the cabinet example again, the SYD is 55 since its useful life is 10 years. Under the SYD method, here’s how you can calculate the furniture’s depreciation:
Depreciation = (9 / 55) x ($1,000 – $200)
Depreciation = 0.16 x $800
Depreciation = $128
For the first year, you’ll record a depreciation of $128 which is slightly lower than the first year depreciation under the double-declining balance.
Depreciation = (8 / 55) x ($1,000 – $200)
Depreciation = 0.145 x $800
Depreciation = $116
Notice that the second year’s depreciation is lower than the first. But the difference is not as dramatic as the double declining balance method.
How to Calculate Depreciation for Tax Purposes
The IRS has pretty strict standards when it comes to depreciation for tax purposes. The agency requires businesses to use the Modified Accelerated Cost Recovery System (MACRS) depreciation method for tax returns.
Under MACRS, assets are assigned to a specific asset class. The class they’re assigned to determines their useful life. So if you’re preparing your tax returns, you can’t just make up a depreciation amount for your office equipment. A detailed table of asset classes can be found in the IRS Publication 946, Appendix B.
Calculating depreciation through the MACRS method is complicated and confusing. So it’s better to leave it to your bookkeeper or accountant. To get a better feel of how MACRS works, there are a lot of depreciation calculators online you can try out.
Which Office Furniture Can Be Depreciated?
Yes, all office furniture depreciates. But you can only record a depreciation expense for a piece of furniture if you:
- own it
- use it in your business or to produce income
- can determine its useful life
- expect it to last more than a year
If the furniture doesn’t fit any of the above criteria, they are not considered depreciable assets. Thus, they can’t be subjected to depreciation.f