What is the Depreciation Rate and How to Determine it?

Depreciation Rate:

The rate or percentage at which the value of a fixed asset is depreciated using any method is called the depreciation rate.

In other words, the depreciation rate is the rate that we use to charge fixed assets as depreciation expenses that report periodically in the income statement.

The result value that comes from this calculation is subtracted from the value of the asset and charged to the income statement of the entity.

Or it is provided based on types and classes of fixed assets.

The rate is usually calculated on yearly basis but you can calculate for any period of time by dividing the yearly amount and adjusting to the said period.

Here are the normal useful life and depreciation methods that are using for some of the fixed assets.

Fixed AssetNormal Useful LifeDepreciation Method
Buildings20 to 50 yearsStraight-line
Machinery and Equipment5 to 20 yearsStraight-line
Vehicles3 to 10 yearsStraight-line
Furniture and Fixtures5 to 10 yearsStraight-line
Computer Hardware3 to 5 yearsStraight-line
Land ImprovementsVariesStraight-line or None*
Leasehold ImprovementsShorter of lease term or useful lifeStraight-line

*Land is typically not depreciated, but any improvements on land may be depreciated over their useful life.

Car Depreciation Rate by Model 2023

ModelYear 1 DepreciationYear 3 DepreciationYear 5 Depreciation
Abarth 50025%40%55%
Aston Martin DB915%35%50%
Audi A420%35%50%
BMW 3 Series20%35%50%
Cadillac Escalade35%50%65%
Chevy Camaro25%40%55%
Dodge Charger30%45%60%
Ferrari 488 GTB10%25%40%
Ford F-15020%35%50%

Car Depreciation Rate by Model 2023

ModelYear 1 DepreciationYear 3 DepreciationYear 5 Depreciation
Abarth 50025%40%55%
Aston Martin DB915%35%50%
Audi A420%35%50%
BMW 3 Series20%35%50%
Cadillac Escalade35%50%65%
Chevy Camaro25%40%55%
Dodge Charger30%45%60%
Ferrari 488 GTB10%25%40%
Ford F-15020%35%50%

Methods for Calculation Depreciation Expense:

The natural wear and tear that comes in the life of a non-current asset due to its use are called depreciation expense. 

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Every company selects the method of depreciation according to its needs.

But the large companies are mostly using the Straight-line method. As it is also preferable by GAAP. The other methods are:

The depreciation rate in the base or assumption on which value of the asset is depreciated. This assumption may differ from method to method.

Like in the straight-line method we use the estimated life as the base for calculating the depreciation expense.

Depreciation Rate under Straight Line Method:

The formula or rate in a straight line can be calculated by using the following formula:

Depreciation Expense = Total Cost of an Asset/Estimated Useful Life

Then,

The Depreciation Rate Formula will be = (Total Cost of an Asset/Estimated Useful Life) *100

The value that comes from this calculation can be called a depreciation rate for calculating depreciation expense under the straight-line method.

Depreciation Rate under Units of Production Method:

The depreciation rate under this method is calculated by dividing the total cost of an asset by the estimated production capacity of the asset.

And then this rate is multiplied with the production of every period to get the depreciation expense.

This rate under this method will be fixed throughout the whole life asset. The formula to calculate the rate of depreciation under the units of production method is:

Rate under Units of Production Method= Total Cost of Asset-Estimated Salvage value / Estimated Capacity of production

This method is useful for seasonal companies as it provides the required fluctuation in the depreciation expense according to the production of units.

Depreciation Rate under Sum of Years Method:

The sum of year digit method is calculated on the assumption that the productivity of an asset decreases with the passage of time.

Related article  Declining Balance or Reducing Balance Method of Depreciation

Under this method, the rate is high in the initial days of an asset which results in high depreciation expenses, and with the passage of time, the depreciation expense is decreasing as the rate also goes downwards.

The formula to determine the depreciation rate is

Depreciation Expense= (Remaining Useful life of Asset/ Sum of years Digits) *Depreciable cost

For Example:

The company XYZ purchased a machine on January 1, 2019. The relevant information is given below

Cost of the machine: $450,000

Expected useful life of machine: 5 years

Salvage value: $50,000

Required: Prepare a schedule showing the depreciation expense of each year of the useful life of the machine using sum of years’ digits method.

Solution:

Year Depreciation Base Remaining life of machine Depreciation fraction Depreciation expense Book value
1 400,000 5 5/15 133,333 266,666
2 400,000 4 4/15 106,666 159,999
3 400,000 3 3/15 80,000 79,999
4 400,000 2 2/15 53,333 26,665
5 400000 1 1/15 26,664

Double Declining Method:

This is not a common type of method used for depreciation. This is also called the 200 percent declining balance method.

In this method, the rate of depreciation is higher in the early years but lower at the lower stage of asset life.

Some people resemble it as the faster shape of the straight-line method. Because if you look at the formulas of both you will understand.

Straight line depreciation rate=depreciation expense/depreciable base

Using this formula to calculate double declining depreciable rate=straight line depreciable rate*2

How to Account for Change in Depreciation Rate Under IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors?

Under IAS 8, “Accounting Policies, Changes in Accounting Estimates and Errors,” changes in depreciation rates are considered changes in accounting estimates rather than changes in accounting policies. 

Here’s how to account for a change in depreciation rate under IAS 8:

  1. Prospective Approach: If the change in depreciation rate affects only future periods and does not impact the carrying amounts of assets in prior periods, it is accounted for prospectively. This means that the new depreciation rate is applied to the remaining useful life of the affected assets, and the carrying amounts are adjusted accordingly from the change date.
  2. Adjustment to Depreciation Expense: To calculate the depreciation expense for the remaining useful life of the assets after the change, you’ll need to consider the carrying amount of the asset at the date of the change, the remaining useful life based on the new depreciation rate, and any estimated residual value. The new depreciation expense is then recognized in the financial statements from the change date and in the future.
  3. Disclosure: It’s essential to disclose the nature of the change in accounting estimate, its reason, and its financial impact. The disclosure should be transparent and provide users of the financial statements with an understanding of the change’s implications.
  4. No Restatement: IAS 8 prohibits the restatement of prior periods for changes in accounting estimates. Therefore, the carrying amounts of assets in prior periods are not adjusted to reflect the new depreciation rate.
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Example:

Let’s assume a company changes the depreciation rate for its machinery from 10% to 8% due to a change in the estimated useful life of the machinery.

  1. The carrying amount of the machinery at the date of the change is $100,000, and its remaining useful life is estimated to be five years after the change.
  2. The previous annual depreciation expense was $10,000 (10% of $100,000), but the new annual depreciation expense will be $8,000 (8% of $100,000).

The company will adjust its depreciation expense in the financial statements from the change date to reflect the new rate of $8,000 annually.

Remember, any changes in depreciation methods (e.g., switching from straight-line to reducing balance) are considered changes in accounting policies and are subject to different accounting treatment, which might require restating prior periods.

What is the Depreciation Recapture Tax Rate?

Depreciation recapture tax is a tax on the gain realized from the sale or disposition of certain assets for which depreciation deductions were previously claimed. 

The tax rate for depreciation recapture depends on the type of asset being sold and the tax laws in the relevant jurisdiction. 

In the United States, for example, depreciation recapture is often associated with selling real property and depreciable business assets.

In the U.S., the tax rate for depreciation recapture on real property is generally 25%. 

This rate applies to the portion of the gain attributable to the depreciation deductions previously taken by the taxpayer. 

The remaining gain, considered a capital gain, may be subject to different tax rates, such as the long-term capital gains tax rates.

For depreciable business assets, such as equipment and machinery, the tax rate for depreciation recapture is typically the taxpayer’s ordinary income tax rate, which can be higher than the capital gains tax rate.

It’s important to note that tax laws and rates can vary depending on the country and specific circumstances of the taxpayer. 

Therefore, individuals and businesses should consult with a tax professional or accountant to understand the depreciation recapture tax rules and rates that apply in their particular situation.