# Depreciation

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```					                      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

EGR 312 - 26                                                    1
Why is depreciation important?

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.

EGR 312 - 26                                            2
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.

EGR 312 - 26                                                     3
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.

EGR 312 - 26                                                    4
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
EGR 312 - 26                                                 5
SL Depreciation
Book value (SL):
BVt  B  tDt

Depreciation rate is constant:

1
d  dt 
n

EGR 312 - 26                             6
SL Depreciation
Example: A \$20,000 vehicle is to be depreciated over
7 years using SL depreciation.

Year     Book Value     Dt                                 Straight Line Depreciation
0        \$20,000
\$25,000
1        \$17,143      \$2,857                \$20,000

Book Value
2        \$14,286      \$2,857                \$15,000
3        \$11,429      \$2,857                \$10,000

4         \$8,571      \$2,857                 \$5,000
\$0
5         \$5,714      \$2,857
0          2         4           6   8
6         \$2,857      \$2,857                                              Year
7           \$0        \$2,857

EGR 312 - 26                                                                                      7
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 = ______________

EGR 312 - 26                                              8
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

EGR 312 - 26                                                9
DB Depreciation
Book value (DB):

BVt  B (1  d )   t

BVt  BVt 1  Dt

EGR 312 - 26                             10
DB Depreciation
Example: A \$20,000 vehicle is to be depreciated over 7
years using DB depreciation with a depreciation rate of
0.25.
Year   Book Value    Dt                             Declining Balance Depreciation
0      \$20,000
\$25,000
1      \$15,000     \$5,000
\$20,000

Book Value
2      \$11,250     \$3,750                \$15,000
3       \$8,438     \$2,813                \$10,000
4       \$6,328     \$2,109                 \$5,000
\$0
5       \$4,746     \$1,582
0         2        4        6    8
6       \$3,560     \$1,187                                            Year
7       \$2,670      \$890

EGR 312 - 26                                                                                 11
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)

EGR 312 - 26                                       12
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. 546 for asset groupings.
Examples:
landscaping around the UC
rental house
tooling for new line of refrigerators
EGR 312 - 26                                                13
MACRS
To determine the amount of deprecation each year, use the
following depreciation rate table (table 16-2, pg. 542.)

Depreciation Rate (%) for Each
MACRS Recovery Period in Years
Year     n=3     n=5       n=7        n=10       n=15   n=20
1     33.33     20      14.29         10         5    3.75
2     44.45     32      24.49         18        9.5   7.22
3     14.81   19.2      17.49        14.4      8.55   6.68
4     7.41    11.52     12.49       11.52       7.7   6.18
5             11.52      8.93        9.22      6.93   5.71
6             5.76       8.92        7.37      6.23   5.29
7                        8.93        6.55       5.9   4.89
8                        4.46        6.55       5.9   4.52
9                                    6.55      5.91   4.46
10                                    6.55       5.9   4.46
11                                    3.28      5.91   4.46
12                                               5.9   4.46
13                                              5.91   4.46
14                                               5.9   4.46
15                                              5.91   4.46
16                                              2.95   4.46
17-20                                                   4.46
21                                                     2.23

EGR 312 - 26                                                                  14
MACRS
Example: A \$20,000 vehicle is to be depreciated for
tax purposes.

MACRS Depreciation
Year        Book Value   dt       Dt
0         20000                                 25000

1         16000      0.2    4000                20000

Book Value
2          9600     0.32    6400                15000

3          5760    0.192    3840                10000

4          3456   0.1152    2304                5000

5          1152   0.1152    2304                   0
0   1      2     3          4   5   6   7
6             0   0.0576    1152                                             Year

EGR 312 - 26                                                                                              15

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