MER 439 Design of Thermal Fluid Systems

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• MER 439 - Design of Thermal Fluid Systems
• Engineering Economics
• Depreciation Methods
• Professor Bruno
• Fall Term 2006

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Depreciation

• Reduction in the value of an asset with time
• Book Depreciation used by a business to keep
  track of the value of their assets at any given
  time
• Tax Depreciation Used to determine write-offs
  against income caused by depreciation. MUST BE
  DONE USING A GOVT APPROVED METHOD

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Concepts of Value

• Market Value
• Price at which property could actually be sold
• Value to owner
• Money amount that would be sufficient to
  compensate owner if the owner were to be deprived
  of the property

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Depreciation Terminology

• Depreciation reduction in the value of an asset
  using (government) approved rules
• Dt depreciation amount
• B first cost (installed cost of asset)
• (Also called the Unadjusted Basis or simply
  Basis hence the B)
• BVt book value - represents the remaining
  un- depreciated investment (value) on the books.
  Determined at the end of the year
• Note the t subscript refers to time in years

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Depreciation Terminology

• n recovery period (depreciable life of asset in
  years)
• dt depreciation rate (fraction of first cost
  removed by depreciation in a given year).
• SV salvage value (estimated market value at the
  end of an assets useful life).

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Depreciation Terminology

• Depreciation is allowed for two types of
  property
• Personal Property income producing tangible
  possessions of a corporation used to conduct
  business
• Real Property real estate buildings etc (land is
  not depreciable)

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Methods of Depreciation Accounting

• (1)Accelerated methods - give a greater write off
  in the early years (declining balance, MACRS)
• (2) Uniform Methods - give a uniform write off
  throughout the entire service life.
  (straight-line)
• (3) Decelerated Methods - give a smaller write
  off in the early years. (sinking fund)
• CHOICE IS INFLUENCED BY TAX LAWS

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Straight Line Depreciation

• Dt is the depreciation charge in year t and BVt
  is the book value at the end of the tth year
  after the depreciation charge has been made.

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SL Depreciation Example

• Consider a machine tool with a first cost of
  35,000 an estimated life of 20 years and an
  estimated salvage value of 3,500. Use SL
  depreciation and calculate the depreciation
  charge and the book value of the machine tool
  after 4 years.

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SL Depreciation Example
B 35,000 SV 3500 n 20
1/20 0.05
0.05(35000-3500) 1575
35000 4(1575) 28700
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Declining Balance Depreciation

• Assets are commonly worth more in initial years
  it is sensible to write off costs more rapidly
  in the early years.
• Declining Balance a given depreciation rate (d)
  is applied to the remaining book value each year.
• i.e. 10 applied to a 35,000 asset
• 1st year Dt 0.10(35000) 3500
• 2nd year Dt 0.10(35000-3500) 3150

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Declining Balance Depreciation

• The maximum allowable percentage is double the
  straight line rate (also called Double Declining
  Balance or DDB method)
• dmax 2/n
• The actual depreciation rate is dt d(1-d)t-1
• Dt dBVt-1
• Dt dB(1-d)t-1
• BVt B(1-d)t
• With the DB method the BV never goes to zero.
• However, no asset can be depreciated below the SV!

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DB Depreciation Example

• Assume that an asset has a first cost of 25,000
  and an estimate salvage value of 4000 after 12
  years, Calculate its depreciation and book value
  for (a) year one and (b) year four using the DDB
  method.

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DB Depreciation Example

• First Compute the depreciation rate
• d 2/n 2/12 0.1667
• For the first year
• D1 0.166725000(1-0.1667)1-14167
• BV1 25000(1-.01667)1 20,832.50
• Year 4 D 2411.46, BV 12,054

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MACRS

• Economic Reform Act (1981) ACRS
• Tax Reform Act (1986) - MACRS
• Applies to property placed in service after
  12/31/86
• Doesnt use useful life or SV
• Property is organized into ASSET Classes and
  assigned a Class Life.

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MACRS

• Dt dtB
• (dt is set by the government)
• BVt BVt-1-Dt
• The first cost is always completely depreciated
  assumes SV 0

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MACRS Depreciation Example

• Calculate the depreciation charge and book value
  for an asset worth 100,000 using MACRS
  depreciation with a three year recovery period.