Depreciation

1
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

2
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.

3
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 corporations 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.
• 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)
• Depreciation rate is constant

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SL Depreciation

• Example A 20,000 vehicle is to be depreciated
  over 7 years using SL depreciation.

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 ______________

9
Declining Balance (DB) Depreciation

• Book value depreciates by a fixed percentage of
  the book value, not a fixed amount.
• 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)

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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.

12
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)

13
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.)

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MACRS

• Example A 20,000 vehicle is to be depreciated
  for tax purposes.