Transcript Depreciation

Depreciation
Depreciation – the reduction in value of an asset. Used
to reflect remaining value of an asset over its
useful life.
Book Depreciation – used by corporations for internal
financial accounting
Tax Depreciation – use in tax calculations in
accordance to government regulations
Depreciation
Why is depreciation important?
Depreciation can lower your taxes:
taxes = (income – deductions)*tax rate
where one of the primary deductions is depreciation.
In other words, the use of depreciation can make you
money by reducing the amount of taxes you pay.
Depreciation
Definitions
First Cost – cost of purchasing and installing an asset
(on real-estate, the value of land is excluded)
Book Value – the remaining, undepreciated capital of
an asset which is on the corporation’s books; the
first cost minus the sum of all deprecation taken
Recovery Period – depreciable life of the asset in
years
Market Value – estimate of the value of an asset if sold
on the open market, not necessarily the same as
the book value.
Depreciation
Definitions
Depreciation Rate – the fraction of the “First Cost”
removed by depreciation each year.
Personal Property – allowed for depreciation, includes
items such as manufacturing equipment, vehicles,
computers, etc.
Real Property – also allowed for depreciation, includes
office buildings, warehouses, manufacturing
facilities, etc… note, land is not depreciated.
Half-year convention – assumes assets are placed in
service in midyear.
Depreciation
Straight Line (SL) Depreciation
Book value depreciates linearly with time. In other
words, depreciation is removed in equal amounts
each year.
BS
Dt  ( B  S )d 
n
Where t = year (1,2,… n)
Dt = annual depreciation charge
B = first cost
S = estimated salvage value
n = recovery period
d = depreciation rate = 1/n
Depreciation
Straight Line (SL) Depreciation
Book value (SL):
BVt  B  tDt
Depreciation rate is constant:
1
d  dt 
n
Depreciation
Straight Line (SL) Depreciation
Example: A $20,000 vehicle is to be depreciated over
7 years using SL depreciation.
Book Value
$20,000
$17,143
$14,286
$11,429
$8,571
$5,714
$2,857
$0
Dt
$2,857
$2,857
$2,857
$2,857
$2,857
$2,857
$2,857
Straight Line Depreciation
$25,000
Book Value
Year
0
1
2
3
4
5
6
7
$20,000
$15,000
$10,000
$5,000
$0
0
2
4
Year
6
8
Depreciation
Straight Line (SL) Depreciation
Example: What would the yearly depreciation and
depreciation rate be if the $20,000 vehicle is
expected to have a salvage value of $6,000?
Dt = _____________
d = ______________
Depreciation
Declining Balance (DB) Depreciation
Book value depreciates by a fixed percentage of the
book value, not a fixed amount.
Dt  dBVt 1
Where t = year (1,2,… n)
BVt-1 = book value in year t - 1
Dt = depreciation amount in year t
d = depreciation rate
Depreciation
Declining Balance (DB) Depreciation
Book value (DB):
BVt  B(1  d ) t
BVt  BVt 1  Dt
Depreciation
Declining Balance (DB) Depreciation
Example: A $20,000 vehicle is to be depreciated over
7 years using DB depreciation with a depreciation
rate of .25.
Book Value
$20,000
$15,000
$11,250
$8,438
$6,328
$4,746
$3,560
$2,670
Dt
$5,000
$3,750
$2,813
$2,109
$1,582
$1,187
$890
Declining Balance Depreciation
$25,000
Book Value
Year
0
1
2
3
4
5
6
7
$20,000
$15,000
$10,000
$5,000
$0
0
2
4
Year
6
8
Depreciation
Double Declining Balance (DDB) Depreciation
The maximum annual depreciation rate for DB method
is:
dmax = 2/n
In this case, the method is called double declining
balance (DDB)
Depreciation
Modified Accelerated Cost Recovery System (MACRS)
MACRS is the US government accepted depreciation
schedule for tax purposes. MACRS combines
facets of DDB and SL methods.
Assets are grouped into categories based on recovery
periods of 3, 5, 7, 10, 15, 20, 27.5, and 39 years.
See table 16-4, pg. 522 for asset groupings.
Depreciation
Modified Accelerated Cost Recovery System (MACRS)
To determine the amount of deprecation each year, use the
following depreciation rate table (table 16-2, pg. 518.)
Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17-20
21
n=3
33.33
44.45
14.81
7.41
Depreciation Rate (%) for Each
MACRS Recovery Period in Years
n=5
n=7
n=10
n=15
20
14.29
10
5
32
24.49
18
9.5
19.2
17.49
14.4
8.55
11.52
12.49
11.52
7.7
11.52
8.93
9.22
6.93
5.76
8.92
7.37
6.23
8.93
6.55
5.9
4.46
6.55
5.9
6.55
5.91
6.55
5.9
3.28
5.91
5.9
5.91
5.9
5.91
2.95
n=20
3.75
7.22
6.68
6.18
5.71
5.29
4.89
4.52
4.46
4.46
4.46
4.46
4.46
4.46
4.46
4.46
4.46
2.23
Depreciation
Modified Accelerated Cost Recovery System (MACRS)
Example: A $20,000 vehicle is to be depreciated for
tax purposes.
0
1
2
3
4
5
6
Book Value
20000
16000
9600
5760
3456
1152
0
dt
MACRS Depreciation
Dt
25000
0.2
0.32
0.192
0.1152
0.1152
0.0576
4000
6400
3840
2304
2304
1152
20000
Book Value
Year
15000
10000
5000
0
0
1
2
3
4
Year
5
6
7