What machine and equipment depreciation is
Machine depreciation spreads the cost of equipment, less its salvage value, over its useful life. It recognizes period by period the wear and obsolescence of the asset, and it flows into product cost and the company’s results.
Depreciating is not spending cash: the outlay happened at purchase. Depreciation is an accounting cost or expense that leaves no cash behind, but it lowers taxable profit and is part of the production cost of every part. The asset is booked at acquisition cost and depreciation reduces it down to salvage value.
Three inputs define any method: the depreciable amount (acquisition cost minus salvage value), the estimated useful life, and the consumption pattern of the asset’s benefits. Land is not depreciated.
Visual map of depreciation methods
The map compares the four methods on the same $120,000 machine and shows book value at the end of each year.
Formulas for the four methods
Depreciable amount = acquisition cost − salvage value
- Straight-line: annual depreciation = depreciable amount ÷ useful life in years. Constant charge.
- Declining balance: yearly depreciation = book value at start of year × rate. The rate is often twice the straight-line rate (double-declining balance). Never depreciate below salvage value.
- Sum-of-the-years-digits: yearly depreciation = depreciable amount × (remaining years ÷ sum of digits). For 5 years the sum is 1+2+3+4+5 = 15.
- Units of production (or machine hours): period depreciation = depreciable amount ÷ total estimated output × output in the period.
Accelerated methods front-load the expense; straight-line and units of production follow time and usage respectively. The choice should reflect how the machine actually delivers benefit.
Worked example: a $120,000 machining center
Fictional example. Acquisition cost $120,000, salvage value $20,000, useful life 5 years, estimated lifetime output 100,000 parts. Depreciable amount: 120,000 − 20,000 = $100,000.
Straight-line: 100,000 ÷ 5 = $20,000 per year (20% of the depreciable amount), or $1,666.67 per month.
Declining balance (40% rate): year 1: 120,000 × 40% = 48,000; year 2: 72,000 × 40% = 28,800; year 3: 43,200 × 40% = 17,280; year 4: the formula gives 10,368, but book value would fall to 15,552, below salvage, so it is capped at 25,920 − 20,000 = 5,920; year 5: zero.
Units of production: rate per part = 100,000 ÷ 100,000 = $1.00. Output was 25,000, 30,000, 20,000, 15,000 and 10,000 parts over the five years.
Sum-of-the-years-digits: fractions of 5/15, 4/15, 3/15, 2/15 and 1/15 of $100,000.
Annual depreciation ($):
| Year | Straight-line | Declining balance (40%) | Sum of digits | Units of production |
|---|---|---|---|---|
| 1 | 20,000.00 | 48,000.00 | 33,333.33 | 25,000.00 |
| 2 | 20,000.00 | 28,800.00 | 26,666.67 | 30,000.00 |
| 3 | 20,000.00 | 17,280.00 | 20,000.00 | 20,000.00 |
| 4 | 20,000.00 | 5,920.00 | 13,333.33 | 15,000.00 |
| 5 | 20,000.00 | 0.00 | 6,666.67 | 10,000.00 |
| Total | 100,000.00 | 100,000.00 | 100,000.00 | 100,000.00 |
Book value at year end ($):
| Year | Straight-line | Declining balance (40%) | Sum of digits | Units of production |
|---|---|---|---|---|
| 0 | 120,000.00 | 120,000.00 | 120,000.00 | 120,000.00 |
| 1 | 100,000.00 | 72,000.00 | 86,666.67 | 95,000.00 |
| 2 | 80,000.00 | 43,200.00 | 60,000.00 | 65,000.00 |
| 3 | 60,000.00 | 25,920.00 | 40,000.00 | 45,000.00 |
| 4 | 40,000.00 | 20,000.00 | 26,666.67 | 30,000.00 |
| 5 | 20,000.00 | 20,000.00 | 20,000.00 | 20,000.00 |
All methods end at the same $20,000 salvage value and depreciate the same total; only the pace differs. In year 1, declining balance ($48,000) charges $28,000 more expense than straight-line ($20,000).
How to choose the method
| Method | When it fits | Watch out for |
|---|---|---|
| Straight-line | Wear proportional to time; steady-use equipment; simplicity | Ignores that the machine may produce more early on |
| Declining balance / sum of digits | Value or productivity drops faster in early years; fast-aging technology | High early expense and lower profit in the first years |
| Units of production / machine hours | Usage varies a lot between periods; life tied to volume | Needs reliable hour-meter or output tracking |
In investment decisions depreciation also has a tax effect: because it lowers taxable profit, it creates a tax saving that enters the cash flow in NPV, IRR and payback. To compare machines over their whole life, use TCO.
Depreciation in the machine-hour rate
On the shop floor, depreciation becomes a cost per machine hour, used in quotes and in decisions such as make or buy. In the example, with 4,000 operating hours a year, straight-line depreciation equals 20,000 ÷ 4,000 = $5.00 per hour. Energy, maintenance, tooling and labor are added on top.
If the machine runs less than planned, the cost per hour rises, because straight-line depreciation is fixed. This ties to capacity utilization and the break-even point: an idle asset keeps depreciating. To find where the machine loses hours, use OEE.
Two notes on rules. Under IFRS, IAS 16 requires depreciation over the useful life using a method that reflects the pattern of consumption of benefits, with useful life, residual value and method reviewed at least at each financial year end; depreciation starts when the asset is available for use. Tax depreciation follows local tax rules, which can differ from the accounting life, so check the rules in force in your country before applying them.
Step-by-step calculation
- Collect the acquisition cost, including freight, installation and testing needed to bring the machine into use.
- Estimate salvage value and useful life from history, engineering and maintenance input.
- Choose the method according to the usage pattern and record the reasoning.
- Build the annual table with depreciation, accumulated depreciation and book value.
- Review useful life and salvage value every year and adjust prospectively when they change.
Common mistakes
- Depreciating the full cost, without deducting salvage value, in straight-line, sum-of-digits and units-of-production methods.
- Letting declining balance push book value below salvage; the last year must be capped.
- Confusing depreciation with a cash reserve to replace the machine: the accounting entry builds no financial fund.
- Keeping the accounting life unchanged for years after a rebuild, component swap or change in shifts.
- Leaving depreciation out of the hourly cost and the selling price, which understates real cost.
Frequently asked questions
What is machine depreciation?
It is the allocation of a machine’s cost, less salvage value, over its useful life, recognizing wear and obsolescence as a cost or expense.
What is the straight-line depreciation formula?
(Acquisition cost − salvage value) ÷ useful life. In the example: (120,000 − 20,000) ÷ 5 = $20,000 per year.
What is the difference between straight-line and accelerated depreciation?
Straight-line splits the cost equally across the years; accelerated methods such as declining balance charge a larger share in the early years.
Can a fully depreciated machine stay in use?
Yes. Book value reaches salvage value but the machine keeps producing; that is a cue to review the estimated life and plan replacement.
Does depreciation use cash?
No. The cash left at purchase. Depreciation is an accounting cost that lowers profit and, with it, the tax on profit.
What is salvage value?
It is the estimated value of the machine at the end of its useful life, net of selling costs. It can be zero when no sale is expected.
Sources
- IFRS FOUNDATION. IAS 16: Property, Plant and Equipment.
- KIESO, D. E.; WEYGANDT, J. J.; WARFIELD, T. D. Intermediate Accounting. Wiley.
- HORNGREN, C. T.; DATAR, S. M.; RAJAN, M. V. Cost Accounting: A Managerial Emphasis. Pearson.
- GARRISON, R. H.; NOREEN, E. W.; BREWER, P. C. Managerial Accounting. McGraw-Hill.
Keep studying: trusted sources and links
- Sebrae: gestão, custos e finanças para empresas (in Portuguese)
- CFC: Conselho Federal de Contabilidade (in Portuguese)
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About the author
Lean Manufacturing & Behavioral Management Specialist
Over 20 years in the automotive and metalworking industries (GM and Dana), Lean Manufacturing practitioner since 2006. SENAI instructor and mentor in Brazil’s Brasil Mais Produtivo program, delivering consulting, training and audits for 50+ companies, combining quality, productivity and people development.
