Depreciation is an accounting term that helps individuals, and especially companies, to lower their tax burdens. Depreciation is defined as the decrease in the value of an asset over its useful life, and the different depreciation methods calculate how much depreciation per year a specific asset should incur. There are various methods, and among the most common are the straight-line method, the declining-balance method and the sum-of-the-years'-digit method.
Advantages of the Straight-Line Method
The straight-line depreciation method calculates depreciation based on the asset's price of purchase, its salvage value and its useful life. An asset's salvage value is how much this asset is worth after its useful life has ended. This value can be a positive number, zero or a negative number. The first advantage of this method is that it is the simplest and easiest method to calculate, mostly because the information you need to calculate depreciation with this method is very basic and because the formula you use is very simple:
(cost of asset - salvage value) / asset's useful life.
Also, with the straight-line depreciation method, you count an even amount of depreciation per year. If you spread the use of your asset out evenly over its useful life, this method is the best option. Because of this even distribution, this method also allows you to easily project your expenses and deductions over the next several years.
Advantages of the Declining-Balance Method
The declining-balance method calculates depreciation with information regarding the asset's price of purchase and the depreciation rate. The depreciation rate is the division of the number 1.5 or 2 (in case you prefer double-declining-balance method) by the asset's useful life. The main advantage of this method is that it allows a greater depreciation for the first years of the asset's life. Some assets experience more use during their first years of life, and for this reason, the declining balance method shows this higher decrease of value during the first years with more accuracy. With the double-declining balance method, the depreciation rate is even faster in the first few years. Another closely related benefit is that it results in a greater reduction of your taxes early on. If your specific situation is such that you can validate the use of this depreciation method, this is a better option than the previous one.
Advantages of Sum-of-the-Years'-Digit Method
This is another type of accelerated method, calculating higher depreciation in the first few years. However, with this method, your depreciation is even higher for the first few years of use than it is with the simple or double-declining-balance method. This method's advantages are very similar to the previous one: it provides a more accurate decrease in the value of the asset if it is being used more heavily in the first years, and it decreases tax burdens faster than the straight-line method does. If, for financial reasons, you prefer an even larger estimate of depreciation during the first years, this is the best method for your business.