When a company purchases an asset, it does not expense the cost of the asset right away. Instead the cost goes to the balance sheet, and, as the asset is used, the cost of the asset moves to the expenses in the income statement. There are three main methods of depreciation: straight-line, double-declining and sum of years' digits. The company can choose which method it wants to use for depreciating its buildings.

Tip

Most businesses depreciate buildings using the straight-line method, where you write off the same amount for each year of the asset's useful life.

## Depreciate Using Straight-Line Method

Determine the cost of the building, any residual value and the economic useful life of the building. The cost of the building is how much the building cost to buy or to build. The residual value is a company estimate based on previous buildings and research on similar buildings for how much the building will be worth at the end of its useful life. The useful life of the building is how long the building should last based on company estimates from past experience and research. For example, Firm A buys a building for \$100,000. The company estimates that the building will have a 25-year useful life and at the end of the 25 years, the building will have a \$5,000 residual value.

Now, subtract the residual value of the building from the cost of the building. This is the depreciable value. In our example, \$100,000 minus \$5,000 equals \$95,000. Divide the depreciable value by the building's useful life to determine the yearly depreciation. In our example, \$95,000 divided by 25 years equals depreciation of \$3,800 a year.

## Depreciate Using the Double-Declining Method

Double-declining balance does not use the residual value so no, you only need to know the cost of the building and the economic useful life of the building as before. The first step here is to divide 2 by the asset's useful life. This is the depreciation base. In our example, 2 divided by 25 equals 0.08. Then, multiply the cost by the depreciation base. In our example, \$100,000 times 0.08 equals \$8,000 of depreciation for the first year.

Subtract the depreciation from the cost of the asset to determine the current value of the asset. In our example, \$100,000 minus \$8,000 equals \$92,000. To figure out year two's depreciation, you should multiply the current value by the depreciation figure for year one. In our example, \$92,000 times 0.08 equals \$7,360. Repeat the steps for each year of the asset's useful life.

## Depreciate Using the Sum-of-Years Digits

Determine the cost of the building, any residual value and the economic useful life of the building as in previous sections. As a reminder, Firm A buys a building for \$100,000. The company estimates that the building will have a 25-year useful life and at the end of the 25 years, the building will have a \$5,000 residual value. Start by subtracting the residual value of the building from the cost of the building. This is the depreciable value. In our example, \$100,000 minus \$5,000 equals \$95,000.

Then, add 1 to the asset's useful life, and label this A. Divide the asset's useful life by 2, and label this B. Multiply A by B. In our example, 25 plus 1 equals 26. Then 25 divided by 2 equals 12.5. Finally, 26 times 12.5 equals 325. Divide the last year number of the asset life by the number you've just calculated. This is the depreciation base for Year 1. Divide the second to last year number of the asset life by the number calculated in Step 3. This is the depreciation base for Year 2. Divide the third to last year number of the asset life by the number calculated in Step 3. This is the depreciation base for Year 3. Repeat this process for each year.

To make sense of this, let's return to our example. Here, 25 divided by 325 equals a depreciation base for Year 1 of 0.0769. Then, 24 divided by 325 equals a depreciation base for Year 2 of 0.0738. Then, 23 divided by 325 equals a depreciation base for Year 3 of 0.0707. Repeat this for all 25 years.

Multiply the deprecation base by the depreciable value to determine the year's depreciation. In our example, for Year 1, \$95,000 times 0.0769 equals \$7,305.50. Then for Year 2, \$95,000 times 0.0738 equals \$7,011. For Year 3, \$95,000 times 0.0707 equals \$6,716.50. Repeat these steps for all 25 years.

## What to Use for Taxes

It's worth noting that the sum-of-years and double-declining methods cannot be used for tax purposes or for tax deductions although they can be useful for accounting purposes. If you are accounting for tax purposes, the only acceptable method listed above is the straight-line method. If you like the double-declining method, you can instead use the similar modified accelerated cost recovery system (MACRS). Ask your tax professional which method will be the most beneficial given your situation.