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
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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.
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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.
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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.
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Straight Line (SL) Depreciation
Book value depreciates linearly with time. In other
words, depreciation is removed in equal amounts each
year.
BS
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
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SL Depreciation
Book value (SL):
BVt B tDt
Depreciation rate is constant:
1
d dt
n
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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
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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 = ______________
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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
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DB Depreciation
Book value (DB):
BVt B (1 d ) t
BVt BVt 1 Dt
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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
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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)
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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
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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
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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
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