Sum of Years Digits – How to calculate ?| For JAIIB

Sum of years digits (SYD) is an accelerated method for calculating an asset’s depreciation. A method known as accelerated depreciation allows more deductions in the earlier years of the asset & gradually decreases in the later years. The method assumes that the asset’s productivity decreases with the passage of time.

Sum of Years Digit is best suited for assets that may become obsolete very soon due to technological advancements, such as computers, automobiles, etc.

How does the method of Sum of years digit works?

Assuming an asset is expected to last for five years, adding together the digits for each year results in 15; so, if the asset was expected to last five years, adding 5 + 4 + 3 + 2 + 1 would generate 15. Each digit is then divided by this sum to determine the depreciation rate each year, starting with the highest number in year 1.

Steps to calculate the Sum of years Digits:

  1. Calculate the depreciable amount by subtracting the salvage value from the acquisition cost of the asset.
  2. Calculate the Sum of Useful Years of the Asset.
  3. Each year, depreciation is multiplied by a depreciation factor. The depreciation factor equals the useful life of the asset divided by the sum of its useful years.
  4. The Sum of years depreciation = Number of useful years/sum of useful years * (Depreciable amount)
  5. If the useful life of an asset is 3. Then, the sum of useful years is = 3 + 2 + 1 = 6 Thus, the factors for each year will be 3/6, 2/6, 1/6 respectively for the 1st, 2nd and 3rd.

Example:

Purchase price of asset = Rs 1,60,000

The useful life of the asset = 5 years

Salvage Value = Rs 10,000

This means that the total amount of Rs 1,50,000 will be spread over its useful life of 5 years.

Here, the sum of the years digits will be = 1 + 2 + 3 + 4 + 5= 15

YEARDEPRECIATIONBASEREMAININGLIFEDEPRECIATIONFRACTIONAMOUNT OF DEPRECIATIONBOOK VALUE
11,50,00055/1550,0001,00,000
21,50,00044/1540,00060,000
31,50,00033/1530,00030,000
41,50,00022/1520,00010,000
51,50,00011/1510,000
    Rs 1,50,000 

As the remaining life of the machine decreases, the depreciation expense also decreases.

Advantages of Sum of Years Digit Method:

  • The sum of years digits method is helpful in matching the cost of the asset and benefit of the asset, which provides over the useful life of an asset. As an asset gets older, its useful life decreases and its benefit decreases. Therefore, charging the asset’s cost higher in the early years and reducing it as time passes reflects the economic conditions and advantages of the asset.
  • During the initial years, the sum of year digits method provides a tax shield. Since depreciation expense is high, the Company can report lower net income, thus reducing tax expense.
  • The sum of the year depreciation method is useful for depreciating an asset that may become obsolete quickly.
  • As compared to other methods, this method reflects the difference in usage of different assets from one period to the next more accurately.

Disadvantages of Sum of Years Digit

This method or any other accelerated depreciation method artificially reduces the reported profit of a business over the near term. It leads to low profits immediately, which are followed by higher profits when the period ends. It is also more complex to calculate than straight-line depreciation, which can lead to errors in the calculation.

Terms used in Sum of Years Digits:

Cost: The initial cost of the asset.

Salvage: This is the value of the asset at the end of the depreciation. It can be zero. It is also known as the salvage value.

Life– This is the useful life of the asset or the number of periods for which the asset will be depreciated.


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