Depreciation of second-hand machinery: What is their useful life?
Depreciation
Importance of machinery depreciation
Calculating the useful life of second-hand industrial machinery?
How can you use second-hand machinery?
How do you calculate depreciation?
Example of depreciation of industrial machinery using the straight-line depreciation method
Choosing the most suitable method
19 February, 2024
Have you ever wondered what is the machinery you have bought or want to buy actually costs? Machinery depreciation could be a useful tool for understanding this and other important issues before and after buying industrial machinery. Find out about it here!
In the machinery industry, depreciation, also known as write-downs, is an accounting process that lets you spread the cost of an item of machinery over its useful life. In other words, the rate at which machinery depreciates through use, and then the action of dividing the total price into small instalments.
This process not only matters for the machinery, but also for a business’ accounts, because when a business buys the machinery, it is considered a tangible fixed asset, meaning an item that the business uses to carry out specific tasks. Therefore, there are two key aspects why this accounting process must be taken into consideration:
-Ensuring the financial statements are more accurate: without depreciation, any machinery cost would be expensed in a single year, which would distort the year’s results. It is also just as important to have tangible information about the value and loss that your products, in this case, industrial machinery, represent.
-Recovering investments: the business needs to recover the money it has invested in the machinery to be able to keep on operating.
However, depreciation matters even more in the case of second-hand machinery, which tends to have more wear and tear, even if it can be used for several more years.
The only difference in the process is that second-hand machinery is written down over a shorter period of time, whereas new machinery tends to be written down over longer periods.
So, let's start at the beginning.
The "useful life" of second-hand machinery refers to the length of time a machine can keep on operating productively and efficiently after another owner has used it.
There are no exact times or values for calculating its useful life, but in doing so you must:
-The type of machinery: some machines, like power tools, have a much shorter service life than others, like lathes or milling machines.
-The quality of the brand: better-known companies tend to manufacture machinery with excellent quality and origin materials, and therefore last longer.
-Maintenance: performing preventive maintenance on industrial machinery extends its useful life significantly.
-Conditions of use: machinery useful life is likely to be shorter if has been used in demanding or hostile environments and tasks.
Did you know that the useful life of second-hand machinery is generally expected to be between 50% and 80% of the useful life of new machinery?
But don’t worry! You stand to benefit in several ways if you buy many types of used machinery. Let's look at them in more detail below.
Like we said, don't let this worry you! You can use second-hand machinery in different contexts and in a variety of ways, including the following:
-Industrial production: it can be used in factories, workshops and industrial facilities to produce various consumer goods.
-Construction: like any machinery, it can be used in construction tasks such as excavation, demolition or earthmoving.
-Agriculture: it can be used on farms for planting, harvesting or food processing, for example.
-Repair and maintenance: it can be used in repair shops to fix machinery, vehicles or other objects.
These are not the only uses, because owning second-hand industrial machinery brings other benefits, including:
-Price: the main advantage is the price, which is usually 30-70% lower than new machinery.
-Availability: sometimes it is hard to find specific new machinery, whereas the second-hand market offers a wider variety of models and brands.
-Sustainability: buying second-hand machinery is a way of contributing to the planet’s sustainability by cutting waste generation and resource consumption.
Now that you know a little bit more about second-hand machinery, let's keep on talking about how you need to write it down.
You must consider two essential factors when calculating depreciation:
1. The price you paid for the machinery when you bought it.
2. The useful life or the number of years you think the machinery will do the task you bought it for.
There are several methods for calculating depreciation, but the most common is the straight-line method. This method consists of dividing the cost of the asset by its useful life. In other words, dividing the value of the machinery by the number of years you are going to use it.
This example should help you better understand what we are talking about.
-A company buys a machine for 20,000 euros.
-The machine’s estimated useful life is 10 years.
The annual depreciation instalment would be:
Annual fee = 20,000 euros / 10 years = 2,000 euros per year
Every year, you would record a depreciation expense of 2,000 euros in your income statement.
The following table shows how the machine would be depreciated over its useful life:
|
Year |
Net value |
Annual depreciation |
|---|---|---|
|
1 |
€20,000 |
€2,000 |
|
2 |
€18,000 |
€2,000 |
|
3 |
€16,000 |
€2,000 |
|
4 |
€14,000 |
€2,000 |
|
5 |
€12,000 |
€2,000 |
|
6 |
€10,000 |
€2,000 |
|
7 |
€8,000 |
€2,000 |
|
8 |
€6,000 |
€2,000 |
|
9 |
€4,000 |
€2,000 |
|
10 |
€2,000 |
€2,000 |
There are two other methods:
-Declining digits method: this consists of applying a higher depreciation percentage in the first years of the machinery’s useful life.
-Declining balance method: you apply a constant percentage to the machinery’s residual value.
It is important to consider the moment when depreciation starts, which is when you start operating the machinery. It is from then you start calculating its depreciation, because its value starts declining from that moment on.
Which method you choose to depreciate second-hand machinery depends on several factors:
1. Type of machinery
-Machinery with a predictable useful life: in this case, you can use the straight-line or declining digits method.
-Machinery with uncertain useful life: in this case, you can use the declining balance method.
2. Residual value
-High residual value: you can use either the straight-line or the declining balance method.
-Low residual value: you can use the declining digits method.
3. Company accounting policy
-Conservative: ideally, use the straight-line or declining digits method.
-Aggressive: use the declining balance method.
4. Tax implications: you should consult a tax advisor to choose the most suitable method.
Finally, these are the effects of machinery depreciation:
-It reduces the asset’s value on the company's balance sheet: every year, the assets’ value is reduced by the amount of the depreciation.
-It is recorded as an expense in the income statement: this means that depreciation reduces the company's net profit.
Remember: whenever you buy industrial machinery, you should write it down, because this will help you to calculate the real cost of using the machinery, and let you know if your business is really making money or, on the contrary, losing it.
