Part 3  -  Estimate each Fixed Asset's Deprecation for each Forecasted Year

As fixed assets are used, their values decrease. In other words, fixed assets depreciate in value over time as they are used. There are four methods you may choose from to estimate the reduction in value of fixed assets. These methods are: straight-line depreciation, units-of-production depreciation, declining-balance depreciation, and sum-of-the-years depreciation.

The simplest method, straight-line deprecation, tends to be the most frequently used when forecasting financial statements. When this method is used, the "Cost of the Asset" (or appraised value of the asset) minus its "Salvage Value" is divided by the asset's estimated "Useful Life". Useful Life refers to the number of years an asset is expected to be "used" in the business. The Salvage Value is the estimated value of an asset at the end of its Useful Life. For simplicity, many forecasters assume a salvage value of ZERO. Lets look at a quick example using the Straight-line Method of Deprecation.

Assume for a moment, you plan to purchase a computer for you business on January 1, 200Z. Also assume, the computer is expected to cost $4,000 and have a useful life of four (4) years, at which time, it is expected to be worth nothing (IE salvage value = $0.00). How much will the computer depreciation (reduce in value) by December 31, 200Z ? To determine the deprecation expense of the computer, simply take Cost of the computer ($4,000) and minus its Salvage Value ($0.00) and then divided by the computer's estimated Useful Life (4 years).

Cost of the Fixed Asset - Salvage Value =    $4,000 + $0.00 =   $1,000
Useful Life of the Fixed Asset 4 years

Therefore, the computer is expected to deprecate or reduce in value by $1,000 each year. If you purchased the computer on June 30, 200Z instead of January 1, 200Z, then its estimated reduction in value or deprecation expense would be $500 (half of one full year). Therefore, the timing of each purchase is very important when estimating the deprecation of any fixed asset.

In our example, Murray must determine the deprecation expense of each of his fixed asset. To do this he must;

1.   Determine the appraised values of each fixed asset invested into his company;
2.   Estimate the cost of each fixed asset he plans to purchase for his company;
3.   Estimate the useful life of each asset; and
4.   Estimate the salvage value of each fixed asset.

Recall from Part 1 of the Fixed Asset Budget, Murray decided to invest his automobile and his computer & accessories into the company The appraised value of automobile is $6,000 and the appraised value of the computer & accessories is $3,900.

Recall from Part 2 of the Fixed Assets Budget, Murray plans to purchase a Photocopier valued at $4,500 on July 1, 200X and a Laser Printer valued at $1,200 on January 1, 200Y.

Lets assume, Murray estimates the useful life of the Automobile, the Computer & Accessories, the Photocopier, and the Laser Printer to be 3 years. Also assume that Murray estimates the salvage value of all assets will be Zero at the end of their useful lives.

Using the above information, Murray can estimate each asset's annual deprecation (reduction in value) as follows;

The second last column, "deprecation expense per year", represents each asset's estimated reduction in value for one full business year. In other words, if Murray used the Photocopier for one full business year, it's expected to reduce in value by $1,500. Therefore, the photocopier's depreciation expense would be $1,500 for one full business year. In 200X, however, the fixed assets INVESTED in the company on July 1 and the fixed assets PURCHASED on July, 1 will be used for only half of the 200X business year (IE July 1 to December 31, 200X). As a result, in 200X these assets will deprecate by half the yearly rate (illustrated in the last column of the chart above).

At this time, Murray should group similar fixed assets into a single category. For instance, the Computer & Accessories, the Photocopier, and the Laser Printer are similar fixed assets. In other words, they are considered Office Equipment. The only other fixed asset left is the automobile. This will have its own category of the same name (IE "Automobile")

Now Murray can determine the Deprecation Expense for each category for each forecasted business year. To do this, he would simply add together the deprecation expenses of each similar fixed asset. The resulting total would be his deprecation expense for each category (shown below).

As you can see, the 200X Deprecation Expense for the Office Equipment category is $1,400. This was calculated by adding the 200X deprecation expense for the computer & accessories ($650) to the deprecation expense of the photocopier ($750). As a result, Murray's 200X Forecasted Income Statement will have an account called "Deprecation Expense - Office Equipment" totalling $1,400. Please Note: the Laser Printer is not used in calculating the Office Equipment's 200X deprecation expense because Murray plans to buy the Laser printer in January 200Y.

As shown in the above chart, Murray's 200Y Deprecation Expense for the Office Equipment category is $3,200. This was calculated by adding together the 200Y deprecation expense for the computer & accessories ($1,300), and the deprecation expense of the photocopier ($1,500), and the deprecation expense of the Laser Printer ($400). As a result, Murray's 200Y Forecasted Income Statement will have an account called "Deprecation Expense - Office Equipment" totalling $3,200.

Recall from above, Murray calculated the Automobile's deprecation expense for 200X at $1,000. As a result, Murray's 200X Forecasted Income Statement will have an account called "Deprecation Expense - Automobile" for $1,000. Since the 200Y Automobile Deprecation Expense was calculated to be $2,000, Murray's 200Y Forecasted Income Statement will have an account called "Deprecation Expense - Automobile" amounting to $2,000.