If you find yourself in the business of rental equipment management, you will face this critical challenge at one point or another: equipment depreciation.
As time marches on, rental property will experience a natural decline in value due to wear and tear. If you are not prepared for it, depreciated equipment poses a significant problem for your business. Let’s look at some real-life examples:
- Your equipment broke down unexpectedly, which means you have to spend unforeseen money on repairs.
- The same equipment was meant to go out to another project tomorrow. As such, you either have to disappoint your customer and send out an incomplete order, or sub-rent the equipment. Both have a negative impact on your bottom line. Also, you risk losing quality of service and trust from your customers.
Fortunately, there are a few methods you can take to deal with equipment depreciation, or even slow it down. In this article, we will provide solutions to ensure more efficient resource management. You will learn about equipment depreciation life and how to calculate equipment depreciation.
So without further ado, let's delve into the details of equipment rental business depreciation!
1. What is equipment depreciation?
2. What is the value of your rental equipment?
3. 3 ways to calculate rental equipment depreciation
What is equipment depreciation?
Equipment depreciation refers to the reduction in value of your rental equipment over time. This is a natural occurrence, as equipment is not made to last forever. The question is not if it will wear out, but rather when.
In accounting terms, equipment depreciation is used to systematically allocate the initial cost of the equipment over its useful life. This allows businesses in the event rental industry to spread out the cost of the equipment over the years it’s being used, thereby matching the expense with the revenue it generates.
Depreciation is crucial for tax purposes, as it enables the company to deduct a portion of the equipment's cost each year, reducing taxable income.
What is the value of your rental equipment?
Before you can calculate depreciation for an asset, you need to figure out three important things:
- Depreciable cost of the asset: This includes all the costs required to get and start using the asset. It involves the purchase price of the asset, any shipping costs, and other fees related to acquiring the asset.
- Useful life of the asset: This is the number of years the company expects to use the asset before it becomes too old or outdated.
- Estimated salvage value: This is the amount of money the company thinks it can get by selling the asset at the end of its useful life.
As for the depreciable cost, Rentman users can save a lot of time to calculate this. Simply export your registered equipment from the software to Excel or Google Sheets and use the right formula. No need for manual labor!
Even though each piece of equipment is unique, you can still make an educated guess to determine the useful life of an asset based on factors such as:
- Industry Standards: research how long similar types of equipment tend to be used in your industry. This can give you a rough idea of the typical useful life.
- Manufacturer Guidelines: check if the manufacturer provides any recommendations or estimates for the expected useful life of the equipment.
- Technological Advancements: consider how quickly technology in your industry evolves. If the equipment is likely to become obsolete relatively quickly, you might estimate a shorter useful life.
Similarly, there are a couple of ways to estimate the salvage value:
- Comparable Sales: research if there are any similar equipment that has been sold as used. This can provide insights into what kind of value similar items retain.
- Expert Opinions: consult experts in the field who might have experience with similar equipment and can provide their perspective on potential salvage value.
Now that you’ve retrieved this information, it is time to decide which method you should choose to calculate equipment depreciation.
What is the depreciation rate for rental equipment?
There are three common ways to calculate rental equipment depreciation. Make sure it fits your type of rental business:
1. Straight-Line Depreciation
This method involves spreading the cost of the equipment evenly over its useful life. To calculate the annual depreciation, simply divide the original cost of the equipment by its expected lifespan.
Example: A rental business decides to purchase a set of event tents for $20,000. They anticipate being able to rent these tents for about 8 years before they need to replace them with newer ones. At the end of those 8 years, they estimate they can sell the used tents for around $5,000.
With this information, the business can calculate the depreciation of the event tents each year. By dividing the depreciable cost ($20,000) minus the estimated salvage value ($5,000) by the useful life (8 years), they find that the depreciation expense for the tents is $2,125 per year.
2. Declining Balance Depreciation
Also known as the reducing balance method. It allows for higher depreciation in the early years of the equipment's life, gradually reducing the depreciation amount over time.
Example: Let's consider an event rental company that invests in a set of high-quality speakers for $15,000. The company chooses to use the declining balance depreciation method to account for the gradual decrease in value over time. They decide to apply a depreciation rate of 30% to the equipment.
Starting Book Value: $15,000
Depreciation Rate: 30%
Year 1:
Depreciation Expense = Starting Book Value * Depreciation Rate
Depreciation Expense = $15,000 * 0.30 = $4,500
Ending Book Value = Starting Book Value - Depreciation Expense
Ending Book Value = $15,000 - $4,500 = $10,500
Year 2:
Starting Book Value: $10,500
Depreciation Expense = Starting Book Value * Depreciation Rate
Depreciation Expense = $10,500 * 0.30 = $3,150
Ending Book Value = Starting Book Value - Depreciation Expense
Ending Book Value = $10,500 - $3,150 = $7,350
And so on for the remaining years until the book value reaches the estimated salvage value or the value is no longer economically useful.
3. Units of Production Depreciation
This method links the depreciation to the actual usage of the equipment. The more the equipment is used, the greater the depreciation allocated.
Example: Let's consider a delivery company with a fleet of vans. The company purchases a van for $30,000, and it estimates that the van can run for 200,000 miles before it needs replacement. In the first year, the van travels 30,000 miles.
Depreciation per mile = (Cost of Van - Estimated Salvage Value) / Estimated Total Miles
Depreciation Expense = Depreciation per mile * Miles Traveled
Depreciation per mile = ($30,000 - $5,000) / 200,000 = $0.125 per mile
Depreciation Expense = $0.125 * 30,000 = $3,750
The depreciation expense will vary each year based on the number of miles the van travels. So, if in the second year the van travels 40,000 miles, the depreciation expense for that year would be $0.125 * 40,000 = $5,000.
Understanding equipment depreciation and knowing how to calculate it, helps you with pricing strategies, making informed decisions about when to replace your inventory, and properly managing finances! But if possible, it’s of course best to apply practices that will prolong the lifespan of your equipment.
Make informed decisions with equipment depreciation
Understanding equipment depreciation and the methods used to calculate it, is essential for businesses and rental property owners. Properly accounting for equipment depreciation ensures accurate financial reporting and assists in making informed decisions about equipment maintenance, replacement, and investments.
Rentman offers a comprehensive solution to manage your rental equipment: you can set up and add different ledger accounts in order to categorize your sources of income, streamline your financial workflows, accurately calculate equipment depreciation, and make well-informed decisions.