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CHAPTER 16
DEPRECIATION METHODS
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Authored by Don Smith, Texas A&M University 2004
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Book Depreciation
Used by a firm for internal financial
and managerial management.
Tax Depreciation
Used by a firm for state and federal
income tax reporting.
Follows strict rules and regulations.
Tax Depreciation:
Must follow current state and federal
law pertaining to acceptable methods
for computing depreciation for income
tax purposes.
Federal Lever (2001)
MACRS Methods
General Depreciation System (GDS).
Alternate Depreciation System (ADS).
Book value:
Accounting Term,
Reflects the undepreciated (value) on
the firms books at a given point in
time.
May or may not reflect the true market
value of the asset at a point in time.
Market value of an asset is what a
willing buyer and willing seller agree to
consummate a sale or exchange.
Section 16.1
DEPRECIATION TERMINOLOGY
Important Terms and their
meanings
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16.1 Terminology
Included are
most manufacturing and service
industry property-vehicles,
manufacturing equipment, materials
handling devices, computers and
networking equipment,
telephone equipment office furniture,
refining process equipment, and much
more.
Real or Personal;
Productive Assets;
Buildings and structures but not land.
Used in the pursuit of income
generation;
Have a finite, estimatable life
16.1 History
16.1 Today….
It is beneficial to compare:
Straight-line,
SYD, and
DB methods.
The best way is to plot the book
values of each method vs. the
recovery period (time).
See Figure 16.1 on page 510.
16.1 Keeping Up
CHAPTER 16
Section 16.2
STRAIGHT-LINE (SL)
DEPRECIATION
55
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Dt = 1/n
16.2 SL Example
Dt = ( B − S )d [16.1]
B−S
Dt = [16.2]
n
Authored by Don Smith, Texas A&M University 2004
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SLN(B,S,n)
16.2 SL Example
B = $50,000;
“n” = 5 years;
S = $10,000 at t = 5;
Dt for each year is:
($50,000 - $10,000)/5 = $8,000/year
1 $8,000 $42,000
2 8,000 34,000
3 8,000 26,000
4 8,000 18,000
5 8,000 10,000
16.2 SL Observations
CHAPTER 16
Section 16.3
DECLINING BALANCE AND
DOUBLE DECLINING BALANCE
DEPRECIATION
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DB is an accelerated depreciation
method;
Provides greater depreciation
amounts in the early time periods
over straight-line.
The method is more complex that
the SL method.
Requires assuming a DB rate –
normally taken to equal 2 x SL rate.
16.3 DB Rate
Dt = (d ) BVt −1 [16.5]
t −1
dt = (d ) B (1 − d ) [16.6]
Depr. Rate
t −1
Dt = (d ) B (1 − d ) [16.7]
S = BVn = B(1 − d ) n
[16.9]
16.3 DB rate - d
B = $80,000;
n = 10 years;
S = $10,000;
Apply the DB and DDB methods to
compute the depreciation amounts
and associated BV’s.
CHAPTER 16
Section 16.4
MODIFIED ACCELERATED COST
RECOVERY SYSTEM
MACRS
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16.4 Observations
Under MACRS:
The entire Basis (B) is fully depreciated
(recovered) over a specified number of
years (recovery periods).
A “0” salvage value is a functional part
of the MACRS system – by law.
In reality, there may be a positive, “0”,
or negative salvage value at some
point in time.
Adjustments will have to be made at
that time. (Disposal analysis)
B = 1.000
DDB rate = 0.6667;
But only ½ year in year 1 is
permitted by law so,
d1 = 0.6667/2 = 0.3333;
D1 = (0.3333)(1) = 33.33%
BV1 = 1 – 0.3333 = 0.6667
remaining at the end of year 1.
Authored by Don Smith, Texas A&M University 2004
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16.4 Year 2.
BV at the end of year 1: 0.6667B;
To be recovered over 3 years.
Rate for year 2 is (from DDB)
0.6667(0.6667) = 0.4445 or 44.45%
So, d2 = 44.45% and,
D2 = 44.45% of B.
BV2 = BV1 – D2 = 0.6667B – 0.4445B;
BV2 = 0.2222B ( 2 years remaining to
recover).
Authored by Don Smith, Texas A&M University 2004
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16.4 Year 4
1 0.3333 0.6667B
2 0.4445 0.2222B
3 0.1481 0.0741B
4 0.0741 0
1.0000
Authored by Don Smith, Texas A&M University 2004
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CHAPTER 16
Section 16.5
DETERMINING THE MACRS
RECOVERY PERIOD
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3- Year Property:
Special manufacturing and handling
devices, tractors and racehorses.
5- Year Property:
Computers and peripherals,
Duplicating equipment.
Automobiles, trucks, buses,
Cargo containers,
Some manufacturing equipment.
10-Year Class:
Water transportation equipment,
Petroleum refining,
Agricultural processing equipment,
Durable goods manufacturing
equipment,
Ship building.
15-Year Class:
Land improvements,
Landscaping,
Pipelines,
Nuclear power production equipment,
Telephone distribution and switching
equipment.
20-Year Class:
Municipal sewers, (developers)
Farm buildings,
Telephone switching equipment,
Power production equipment,
Water utilities equipment.
1.00
Authored by Don Smith, Texas A&M University 2004
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Cost Depletion
Called “factor depletion”;
Based upon the level of activity or
usage;
Time is not involved.
Percentage Depletion
Applies a constant, stated percentage
of the resource's gross income
provided it does not exceed 50% of the
firm’s current taxable income.
first cost
pt = [16.15]
resource capacity
Warning:
These percents change over time due
to changes in the tax law.
If you are involved in extraction
industry analysis you must keep up
with the current regulations and
percents for this method!
16.6 DEPLETION
Chapter 16 Summary
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Authored by Don Smith, Texas A&M University 2004
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