As the name suggests, the sum of the year’s digits depreciation or SYD is a method to calculate depreciation. Since this method accelerates the recognition of depreciation, it is a form of accelerated depreciation. This means that majority of the depreciation on an asset is recognized in the initial years. Thus, this method assumes that assets are usually more productive when they are new, or the assets become less useful as they grow old.
Formula of Sum of the Years Digits Depreciation
Following is the formula to calculate depreciation using the sum of the year’s digits depreciation method:
Depreciation = Depreciable Base * (Remaining Life/SYD)
Here, Depreciable Base is the difference between the cost of the asset and its salvage value (if any).
SYD is the sum of the useful life year’s digits, meaning the sum of the series till the useful life. For instance, if an asset has a useful life of 5 years, SYD will be 15 (1+2+3+4+5). Another way to calculate SYD is by using the formula n*(n+1)/2, where n is the useful life of the asset in years.
In excel also, there is a function to calculate depreciation based on the SYD method. This function is SYD Function, and its formula is SYD (cost, salvage, life, per).
In the excel function, the cost is the initial cost of the asset.
Salvage is the salvage value at the end of the useful life of the asset. It could be zero as well.
Life is the useful life of an asset.
Per is the year for which the depreciation needs to be calculated, such as the first year, the second year, etc.
Example of Sum of the Years Digits Depreciation
Let us understand how to calculate depreciation using the sum of the year’s digits depreciation method. Suppose Company A has an asset costing $45,000. It has a salvage value of $5000, while its useful life is 4 years.
Now using the above formula, Depreciation = Depreciable Base * (Remaining Life/SYD)
Depreciable Base will be $45,000 Less $5000 or $40,000.
SYD will be 10 (4 *(4+1)/2)
For 1st year (remaining life of 4 years), the depreciation will be = $40,000 * (4/10) = $16,000
For 2nd year (remaining life of 3 years) = $40,000 * (3/10) = $12,000
Depreciation for 3rd year (remaining life of 2 years) = $40,000 * (2/10) = $8,000
For 4th year (remaining life of 1 year) = $40,000 * (1/10) = $4,000
Total depreciation for four years ($16,000 + $12,000 + $8,000 + $4,000) will be $40000. So, the value of the asset at the end of its useful life become zero.
Benefits of SYD Method
Following are the benefits of using the sum of the year’s digits depreciation method:
- It helps to align the cost of using an asset with its use each year over the life of the asset. This means the method is practical as an asset is usually more productive in its early years.
- SYD method helps to maintain a balance between the depreciation amount and the repair and maintenance costs. Depreciation charge is higher in the initial years, while repair and maintenance costs are usually lower in the early years of the asset. Once the asset gets old, its repair and maintenance costs also rise, but the depreciation charge under the SYD method comes down.
- Since the SYD method helps to maintain a balance between the depreciation charge and the repair and maintenance costs, it also helps to ensure that earnings don’t get distorted.
- This method provides the company with a tax shield, especially when the asset is new. Since the depreciation charge is higher in the initial years, it reduces the net income and also the tax liability.
Drawbacks of SYD
One major drawback of using SYD or any other accelerated depreciation method is that it charges more depreciation in the initial years of the asset. This leads to lower profits in the initial years and comparatively more profit in the following years.
Also, this method can indirectly influence the cash flows. As the depreciation is higher in the initial years, the net income is lower. This lowers the tax liability and, therefore, the cash flow.
When to Use SYD Method?
Irrespective of the method (straight-line depreciation method, double-declining balance method, or SYD method) you choose to depreciate the asset, the total amount of depreciation will remain the same. The difference will only be in the timing of depreciation recognition.
So, it is better to go with the sum of the year’s digits depreciation (SYD) method if the asset is more productive in the earlier years or it depreciates more quickly, for example, automobiles.
Also, it is better to use this depreciation method if an asset may become obsolete quickly. For example, a PC or a computer may get obsolete very quickly due to the advancement in technology.
Companies facing difficult tax environments may also prefer the SYD method to realize bigger tax savings in the early years of the assets.