Activity-based depreciation method is a way of calculating the depreciation expense of an asset by taking into account different factors associated with that asset.
This method considers the asset’s cost, estimated life, and expected usage to determine its rate of depreciation.
By using this approach, business owners can better understand how their investments are performing over time.
Let’s break down what activity-based depreciation is, how it works, and how to calculate it.
What Is Activity-Based Depreciation?
Activity-based depreciation is a method for calculating the value of an asset’s depreciation over its lifetime.
It differs from straight-line or accelerated methods in that it considers several variables related to the asset when determining its depreciation rate.
These variables include the asset’s cost, estimated useful life, and expected usage. The idea behind this approach is to more accurately reflect an asset’s true worth as it depreciates over time.
How Does Activity-Based Depreciation Work?
To illustrate how activity-based depreciation works, let’s use a fictional company called ABC Technologies as an example.
ABC bought a piece of equipment for $10,000 with an expected life of 10 years and expects to use it for 8 years before needing to replace it.
Under a straight line or accelerated approach to calculating depreciation expenses, ABC could write off $1,000 per year (assuming they used a straight line) or $2,000 per year (if they used accelerated).
But with activity-based depreciation, ABC could write off more in the early years when they are using the equipment most (say $4,000 in year 1) and less in later years ($500 in year 8).
This allows them to better reflect their actual usage costs for the equipment during its useful life.
How To Calculate Activity-Based Depreciation?
To calculate activity-based depreciation expenses for any given item or pieces of equipment you own or lease, you first need to make sure you have all necessary data points, including purchase price/cost basis of item(s), estimated useful life (in months), and expected usage (in months).
Once you have these figures on hand, you can then calculate your annual rates as follows:
Annual Rate = Cost Basis/Estimated Useful Life * Expected Usage
For our example, we would take $10,000/120*96 = $800 per year, which would then be reported as part of ABC’s total annual operating expenses on their tax return or financial statement, depending on where they were filing it.
That said, if ABC owns multiple pieces of equipment, they will need to do this calculation individually for each item as each one may have different variables associated with it, such as cost basis or expected use period, which could result in other overall annual rates being calculated for each one.
Ultimately activity-based depreciation can offer businesses greater accuracy when reporting their assets’ depreciating value over time which can help them better track the performance of their investments and adjust their strategy accordingly if needed.
Even though this approach may require additional effort initially due to having more variables involved than a straight line or accelerated methods, once all necessary data points are gathered, calculating your annual rates should be relatively straightforward following the formula provided above
Cost Basis/Estimated Useful Life * Expected Usage = Annual Rate! Happy computing!