Every asset and piece of equipment depreciates over time, but that doesn’t necessarily mean it delivers less value. In fact, with the right enterprise asset management solution, you can better track asset and equipment depreciation to lower your taxes while boosting your maintenance operations.
What is equipment depreciation?
The concept behind depreciation is simple. Think back to what you paid for your car. Now make a rough estimate in your head of what you could sell it for today. That second number is going to be lower, because over time, things tend to lose value.
Of course, there are plenty of things that don’t. If only you’d bought a 1968 Ford Mustang GT fastback, you could sell it today for more than what you paid. But as a rule, in an industrial or commercial setting, the things you buy lose value.
Equipment depreciation is a specific type of depreciation: the amount of value your equipment loses each year. And the reason it’s important is that understanding depreciation on machinery helps you with better business intelligence, including critical repair-or-replace decisions.
What types of equipment depreciate?
The better question might be what types of equipment don’t appreciate, and the answer to that is, nothing really. Essentially any type of equipment that you could conceivably use in your organization depreciates. Everything from computers to machine presses to the building you work in depreciates over time.
Even if you were to buy it and leave it unopened and unused, sitting in your warehouse for years, it would depreciate. Last year’s anything goes for less.
There is a difference when it comes to deprecation for tax purposes, however. In the U.S., the Internal Revenue Service (IRS) doesn’t count depreciation costs until the equipment is placed into service at your organization.
So, if you purchase a piece of equipment, but don’t install it and begin using it until the next calendar year, you are not required to count the previous year of depreciation.
While that is the case for tax purposes, even if the equipment was never used, the resale value of that equipment has still depreciated by one year. This is very common with cars.
The deprecation value for vehicles is usually determined by both time and usage (miles driven) but the vehicle does significantly depreciation the moment your drive it off the dealership lot. Even if you drive it down the street and park it for a year, it still has lost quite a bit of value for simply being an older model.
So far, depreciation sounds depressing. You invest money into something only to see it lose value. And because equipment depreciation is how much it loses in a year, that tells you that it’s losing value fairly fast.
But the good news is that depreciation can help you add value to your overall operations, even while your equipment steadily becomes worth less than you paid for it.
Why is equipment deprecation a good thing for maintenance teams?
For a business, equipment deprecation is helpful because it allows you to claim that deprecation on your taxes every year. You can write off your equipment deprecation as a business expense on your taxes, which can lower the amount of taxes your company is required to pay for the year. The more money you get to keep, the easier it is to see a healthy bottom line.
Knowing your equipment depreciation rate is also useful for planning maintenance activities for that asset. When you know the deprecation rate, you can determine if it’s worth continuing to repair the asset beyond a certain point or invest in purchasing a replacement.
These critical repair-or-replace decisions are notoriously challenging, and the stakes are high. If you replace too early, you’re throwing out value. If you replace too late, you’re throwing bad money after good.
Many organizations plan their maintenance operations around the time when they will be unable to continue claiming tax deductions on an asset. They know that when the asset reaches that point, they can replace it, saving themselves additional maintenance costs.
What is the depreciation rate for equipment?
There is no standard timetable for equipment depreciation as it all depends on the industry you’re in and the service your equipment provides to your business. For heavy use industries, some equipment can depreciate as quickly as three years while other equipment such as storage tanks may have a depreciation of 50 years.
For example, light work trucks with an actual weight of fewer than 13,000 lbs have a recommended depreciation period of four years while equipment used in the manufacturing of vegetable oil has an 18-year depreciation time.
The depreciation rate applied to your assets is determined by your accounting department based on your country’s tax laws. In the U.S., the IRS has provided some guidelines on how to properly apply depreciation rates to your equipment based on your industry.
How do you calculate equipment depreciation?
There are actually a few different ways to calculate equipment depreciation, but a lot of people go with straight-line depreciation. And it makes sense, because just like the name suggests, it has the advantage of being straight forward. The formula for calculating equipment deprecation includes:
- Initial value (purchase price)
- Useful life
- Salvage value
Depreciation: initial value
The initial value is the price you paid for the equipment, not necessarily its market value. For example, if the piece of equipment you purchased is typically worth $20,000 but you were able to purchase it for only $18,000, the initial value to you is $18,000.
Depreciation: useful life
You can determine an asset’s useful life a few different ways. For tax purposes, the best method is to consult the governing tax authorities. However, you may choose to use a different method to determine your equipment’s useful life for calculating things like total cost of ownership (TCO) or when to repair or replace an asset.
Depreciation: salvage value
The salvage value is what you could reasonably sell the piece of equipment for at the end of its useful life.
The formula for depreciation is:
Let’s use that asset in the example above, the one you purchased for $18,000. If that asset has a useful life of 5 years and a salvage value of $3,000, then the annual depreciation rate would be $3,000.
Why should you track equipment depreciation with EAM software?
The short answer is that a good EAM platform makes calculating equipment depreciation easier.
Here’s the long answer:
Equipment depreciation is a useful metric to track for your organization, but you trying to do it manually every year is not only inefficient but also a fast way to introduce a lot of mistakes. The best way to keep track of it is to use enterprise asset management (EAM) software.
EAM software helps you track every step of your asset’s journey through your organization from the time you purchase it until you salvage or dispose of it. With it, you can keep track of the TCO as well by tracking maintenance costs, parts used, amount of downtime, and more.
You can also generate detailed reports on the metrics you and your accounting department need to keep track of for your tax purposes at the end of the year.
Equipment depreciation is the amount of value your equipment loses every year until the point where it no longer holds any residual value. Every type of equipment depreciates, and, in most countries, you can claim that deprecation as a business expense on your taxes.
Understanding depreciation can also help you determine the total cost of ownership for your assets and decide when it’s time to replace your equipment.
The best way to keep track of depreciation and use it to make smart investment decisions is with EAM software.