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DEPRECIATION AND ACCOUNTING CONCEPTS. CASH FLOW THROUGH A PROJECT BASED ON THE LIFE OF THE PROJECT PRIMARY COMPONENTS ARE CAPITAL AND OPERATING COSTS.

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Presentation on theme: "DEPRECIATION AND ACCOUNTING CONCEPTS. CASH FLOW THROUGH A PROJECT BASED ON THE LIFE OF THE PROJECT PRIMARY COMPONENTS ARE CAPITAL AND OPERATING COSTS."— Presentation transcript:

1 DEPRECIATION AND ACCOUNTING CONCEPTS

2 CASH FLOW THROUGH A PROJECT BASED ON THE LIFE OF THE PROJECT PRIMARY COMPONENTS ARE CAPITAL AND OPERATING COSTS

3 CAPITAL COSTS CAPITAL INVESTMENT FROM TAXED SOURCES FIXED CAPITAL WORKING CAPITAL SALVAGE (S) = VALUE OF CAPITAL AT THE END OF THE PROJECT LIFE AND IS DERIVED AS A POSITIVE CASH FLOW FROM THE PROJECT

4 OPERATING CASH FLOW COMPONENTS REVENUES (R) = PRICE * VOLUME PROFIT = REVENUES - COSTS OF MANUFACTURE (COM) COM = RAW MATERIALS, UTLITILIES, LABOR AND ALL OTHER CONVERSION COSTS

5 CAPITAL RECOVERY CAPITAL RECOVERY = DEPRECIATION (D) THIS IS THE METHOD TO RECOVER PREVIOUSLY TAXED INVESTED CAPITAL WORKING CAPITAL IS EXCLUDED BECAUSE IT IS LIQUID CAPITAL INVESTMENT (CAP) = NEW CAPITAL INVESTED IN THE SUBJECT YEAR

6 ANNUAL CASH FLOW CALCULATION CASH BEFORE TAXES (Cb) = R - COM PROFIT BEFORE TAXES (Pb) = Cb - D PROFIT AFTER TAXES (Pa) = Pb*(1 - TAX) CASH AFTER TAXES (Ca) = Pa + D - CAP

7 CALCULATION OF DEPRECIATION EQUIPMENT INITIAL COST, INITIAL BOOK VALUE, (BV o ) EQUIPMENT COST ESTIMATE COMES FROM DESIGN BASED ESTIMATE EQUIPMENT FINAL VALUE IS THE SALVAGE (S) FINAL VALUE IS NORMALLY BASED ON THE MATERIAL COST (SALVAGED MATERIALS) EQUIPMENT LIFE (n) - (TAX LIFE, NOT NECESSARILY ACTUAL LIFE) EQUIPMENT LIFE IS BASED ON METHODS DEFINED BY CONGRESS (SEE TABLE 7-8 FOR EXAMPLES FROM 1997) DEPRECIATION METHOD (FORMULA TO CALCULATE DEPRECIATION) SEE IRS DOCUMENT “Publication 946 (2005), How To Depreciate Property “ FOR SPECIFIC CRITERIA (http://www.irs.gov/pub/irs-pdf/p946.pdf)http://www.irs.gov/pub/irs-pdf/p946.pdf)

8 DEPRECIATION METHODS CONTROLLED WITH SEVERAL GENERAL RULES SIMPLEST METHOD IS LINEAR (STRAIGHT LINE) OVER THE LIFE OF THE EQUIPMENT NO METHOD CAN HAVE AN ANNUAL PERCENTAGE GREATER THAN TWICE STRAIGHT LINE METHODS CAN BE CHANGED AS LONG AS THE CHANGE IS TO A RATE EQUAL TO OR LOWER THAN THE PREVIOUS METHOD

9 DEPRECIATION METHODS STRAIGHT LINE: THE DEPRECIATION FACTOR: EQUAL AMOUNTS ARE DEPRECIATED IN EACH YEAR

10 DEPRECIATION METHODS DOUBLE DECLINING BALANCE (DDB) THE DEPRECIATION FACTOR IS DOUBLE THE RATE OF THE STRAIGHT LINE ALTERNATELY FOR YEAR j DDB METHOD LEAVES A REMAINDER IN THE LAST YEAR THAT MUST BE DEPRECIATED AT THAT TIME

11 DEPRECIATION METHODS MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) COMBINED METHOD THAT COMBINES DDB AND STRAIGHT LINE TO AVOID A LARGE REMAINDER SEE TABLE 7-9 FOR VALUES NOTE THE FIRST DEPRECIATION IS TAKEN AT THE END OF YEAR 1 RESIDUAL IS TAKEN IN THE YEAR FOLLOWING THE NOMINAL PERIOD

12 MACRS CRITERIA CLASS LIVES AND RECOVERY PERIODS ARE IN THE TAX CODE THERE ARE TWO METHODS General Depreciation System (GDS) Alternative Depreciation System (ADS) RECOVERY PERIODS ARE GENERALLY LONGER UNDER ADS THAN UNDER GDS

13 MACRS ADS RECOVERY PERIOD EXAMPLES

14 DEPRECIATION METHODS SUM OF THE YEAR DIGITS, SOYD CALCULATES THE DEPRECIATION RATE BASED ON THE YEAR OF DEPRECIATION THE DEPRECIATION FACTOR IS BASED ON THE FACTORIAL OF n:

15 DEPRECIATION METHODS SOYD CALCULATIONS AS AN ARITHMETIC PROGRESSION: DEPRECIATION: THIS METHOD DOES NOT HAVE A RESIDUAL


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