How do you calculate diminishing value depreciation?
How does diminishing value depreciation compare to prime cost (straight line) methods?
It is important to understand how to calculate prime cost vs diminishing value depreciation. To begin; let’s explore the two methods to calculate an asset’s depreciation:
- The prime cost depreciation method provides uniform depreciation over an asset’s effective life and is a more simplified method
- The diminishing value depreciation method provides more upfront depreciation during the initial years before reducing over time.
The ATO website provides a nice visual comparison of the two methods shown below. The graph assumes you have acquired an $80,000 asset on the first day of the income year and the asset is used only for business. The effective life has been defined as 5 years.
To understand the depreciation schedules let’s look at how each method has been calculated.
Prime Cost Depreciation Method
This depreciation method calculates the decrease in values of an asset over its effective life at a fixed rate per year using the following formula:
Asset’s cost x (days held ÷ 365) x (100% ÷ asset’s effective life)
In this example the asset has cost $80,000 and has an effective life of 5 years (as per the ATO prime cost vs diminishing value calculation example above) you can claim 20% or $16,000 of the asset’s value in each of the 5 years. The calculation is shown below:
Calculate Prime Cost Depreciation
$80,000 x (365 ÷ 365) x 20% = $16,000
If the asset was acquired mid-way through the year you would update the days held value accordingly and the final calculation would occur in the 6th year.
Diminishing Value Method
The diminishing value method allows for a higher depreciation deduction of the asset in the first years of ownership and then reduces over its effective life using the following formula:
Base value x (days held ÷ 365) x (200% ÷ asset’s effective life)
Using the same example where the asset has cost $80,000 and has an effective life of 5 years – the method to calculate diminishing value depreciation is as shown below:
Calculate Diminishing Value Depreciation
First Year diminishing value claim calculation:
$80,000 × (365 ÷ 365) × (200% ÷ 5) = $32,000
For subsequent years the base value will reduce based on the difference between the current year and the next year. In this example the base value for the second year will be $80,000 – $32,000 = $48,000.
Second Year diminishing value claim calculation:
$48,000 × (365 ÷ 365) × (200% ÷ 5) = $19,200
Third year diminishing value claim:
$28,800 × (365 ÷ 365) × (200% ÷ 5) = $11,520
Fourth year diminishing value claim calculation:
$17,280 × (365 ÷ 365) × (200% ÷ 5) = $6,912
The depreciation will continue until the final value of the asset reaches zero.
Taxable Use & the Low-Value Pool
If your asset is not used 100% for business purposes – the value of the asset is reduced to the extent it is used privately. In the example above; if the asset was used 20% of the time for private purposes the deduction for its decline in value is also reduced by 20%.
Also – assets with a value falling below $1,000 can be transferred to a low value pool allowing you to claim deductions on depreciation for multiple assets together.
And of course, you may be eligible to take advantage of the instant asset write-off rules which change from time to time.
Always seek advice from your accountant as additional benefits and incentives may apply depending on the eligibility of your assets, business size and various stimulus packages.
At AssetAccountant™ our goal is to take the complexity out of the depreciation process – feel free to contact us to find out more!