Presentation on theme: "Chapter 16: Depreciation"— Presentation transcript:
1Chapter 16: Depreciation Business MathChapter 16: Depreciation
216.1 Depreciation methods for financial statement reporting Depreciate an asset and prepare a depreciation scheduleusing the straight-line methodusing the units-of-production methodusing the sum of the years’ – digits methodUsing the declining balance method
3Key TermsAssets: properties owned by the business, including anything of monetary value and anything that can be exchanged for cash or other property.Estimated life or useful life: the number of years an asset is expected to be useable.Salvage value, scrap value, or residual value: an estimated dollar value of an asset at the end of the asset’s estimated life.
4Key TermsDepreciation: the amount an asset decreases in value from its original cost.Straight-line depreciation: a method of depreciation in which the amount of depreciation of an asset is spread equally over the number of years of useful life of the asset.Total cost: the cost of an asset including shipping and installation charges.Depreciable value: the cost of an asset minus the salvage value.
516.1.1. Use the straight line depreciation method Find the total cost of the asset TC = cost + shipping + installationFind the depreciable value Depreciable value = TC – salvage valueFind the yearly depreciation: = depreciable value ÷ years of expected life
6Look at this exampleUse the straight-line method to find the yearly depreciation for a plating machine that has an expected useful life of 5 years. The plating machine cost $27,300; its shipping costs totaled $250, installation charges came to $450 and its salvage value is $1,000.TC= $27,300 + $250 + $450 = $28,000Depreciable value = $28,000 - $1,000 = $27,000Yearly depreciation = $27,000 ÷ 5 = $5,400
7Try this exampleA labeling machine cost $43,000. Installation costs totaled $1,250 and shipping costs totaled $2,250. It has an expected useful life of 10 years. Its salvage value is $2,000. Use the straight-line method of depreciation to find the yearly depreciation for the labeling machine.The depreciation is $4,450 per year.
8Key TermsDepreciation schedule: a table showing the year’s depreciation, the accumulated depreciation, and the end-of-year book value.Accumulated depreciation: the current year’s depreciation plus all previous years’ depreciation.End-of-year book value: total cost minus depreciation for the first year. Thereafter, it is the previous year’s end-of-year book value minus the current year’s depreciation.
916.1.2 Use the units-of-production method Takes into account an asset’s use in terms of production, for example:Items producedMiles drivenHours operatedNumber of times it has performed a specific operationCompanies that use this method internally often adjust to a method acceptable by the IRS for tax-reporting purposes.
10Find the unit depreciation Depreciable value Units produced during expected lifeDepreciation for units produced = unit depreciation x units produced
11Look at this exampleA label making machine that costs $28,000 after shipping and installation is expected to print 50,000,000 labels during its useful life. If the salvage value of the machine is $1,000, find the unit depreciation and the depreciation for printing 2,125,000 labels.(go to next slide)
12Find the depreciationUnit depreciation = depreciable value ÷ units produced during expected lifeUnit production = $27,000/ 50,000,000Unit depreciation = $Depreciation for 2,125,000 labels = $ x 2,125,000 = $1,147.50The depreciation for that number of labels is $1,
13Try this exampleA small pickup truck was purchased for occasional deliveries during the busy season of Eager Enterprises. Total cost of the truck was $24,000. The salvage value is $2,500. The expected number of miles to be driven over the truck’s useful life is 100,000. Find the depreciation after one year is the truck has been driven 3,000 miles.$645 is the depreciation amount
1416.1.3 Use the sum-of-the years’ digits method Sum-of-the-years’ digit method: A depreciation method which allow the greatest depreciation the first year and decreasing amount each year thereafter.Year’s depreciation rate: the depreciation rate for any given year of a depreciation schedule.
15Find the year’s depreciation The numerator of the year’s depreciation rate is the number of years of expected life remaining.The denominator of the year’s depreciation rate is the sum of the numbers from 1 to the years of expected life.Shortcut for finding the sum: n(n+1) = sum
16Look at this exampleFind the depreciation for each of the five years of expected life of a bottle capping machine that costs $27,300 and has a shipping cost of $250 and an installation cost of $450, and a salvage value of $1,000. Make a depreciation schedule.Denominator = 5 (6) ÷ 2 = 15Numerator for year 1 = 5; year 2 = 4 and so on.Depreciable value = TC – salvage valueDepreciable value = $27,000
17Depreciation schedule Year 1 = $27,000 x 5/15 = $9,000 End of year book value = $28,000-$9,000=$19,000Year 2 = $27,000 x 4/15 = $7,200 End of year book value = TC – accumulated depreciation = $11,800Now, calculate the depreciation and book value for Years 3, 4, 5.Y 3 $5,400 and end-of year book value is $6,400. Y 4 $3,600 and end-of year book value is $2,800. Y 5 $1,800 and end-of year book value is $1,000.
1816.1.4 Use the declining balance method of depreciation A depreciation method that provides for large depreciation in the early years of the life of an asset.Double-declining rate (or 200% declining-balance method): a declining balance depreciation that is twice the straight-line depreciation.150% declining rate: a common declining balance rate that is 1 ½ times the straight line rate.
19Find the depreciationYearly double declining rate = yearly straight line depreciation rate x 2Yearly 150% declining depreciation rate = yearly straight line depreciation rate x 1.5First year’s depreciation = total cost x yearly depreciation rateFor all other years: Year’s depreciation = previous end-of-year book value x yearly depreciation rate.
20Look at this exampleAn ice-cream freezer has a useful life of six years. Find the yearly:straight line rate expressed as a decimal and a percentDouble-declining rate expressed as a decimal and a percent.150%-declining rate expressed as a decimal and a percent.
21The rates Straight-line = 1/6 or .1667 or 16.67% Double-declining = 2(1/6) = 1/3 or 33%150% declining rate = 1.5 (1/6) = 0.25 or 25%
22Tip!In declining-balance depreciation, the depreciation for the first year is based on the total cost of the asset.Do not subtract the salvage value from the total cost to find the depreciation in the first year.The end-of-year book value for any year cannot drop below the salvage value of the asset. If the depreciation would cause it to drop below the salvage value, the year’s ending value will be the salvage value.
23Look at this exampleA packaging machine costing $28,000 with an expected life of five years and a resale value of $1,000 is depreciated by the declining balance method at twice the straight-line rate. Prepare a depreciation schedule.Year one (2) 1/5 = 2/5 or 40% or .40$28,000 x 40% = $11,200End of year 1 book value = TC – depreciationEnd of year 1 = $28,000- $11,200 = $16,800
24Finish the depreciation schedule Year Two = previous end-of-year book value x double-declining rate $16,800 x 0.4 = $6,720End-of-year Two book value = previous end-of-year book value – depreciation = $16,800 - $6,720 = $10,080(go to next slide)
25Years 3, 4 and 5Year Three = previous end-of-year book value x double-declining rate = $10,080 x 0.4 = $4,032End-of- year Three book value = $10,080 - $4,032 = $6,048Year Four depreciation = $2, End of year Four book value = $3,628.80Year Five depreciation = $1, End-of-year Five book value = $2,177.28
2616.2 Depreciation Methods for IRS reporting Depreciate an asset and prepare a depreciation schedule using the modified accelerated cost-recovery system (MACRS)Depreciate an asset after taking a section 179
27Using MACRSIn, 1981, the IRS enacted an accelerated cost-recovery system (ACRS) for the depreciation of property put into service after that date.Allowed businesses to write off cost of assets more quickly.Objective was to encourage businesses to invest in more assets despite an economic slowdown at the time.
28Table 16-5Table 16-5 indicates that each recovery period has a depreciation rate for one year more than the recovery period indicates.First and last year in the recovery period are partial years.Greatest amount of depreciation is realized in the second year, which is the first full year.
29Using the MACRS MethodUsing the IRS publication, determine the asset’s recovery period and find the appropriate table.Find the MACRS rate using Table 16-5Multiply the year’s MACRS rate by the total cost of the asset.Year’s Depreciation = Year’s MACRS rate x total cost
30Why is this easier than traditional depreciation methods? 1. You do not have to find a depreciable value.2. You do not have to determine a salvage value.3. The useful life is determined by the property classes.
31Look at this exampleFind the depreciation for each year for a boiler that was purchased for $28,000 and placed in service at midyear under the MACRS method of depreciation as a five-year property.Year 1 depreciation = MACRS rate x Total CostYear 1 depreciation = 20% x $28,000Year 1 depreciation = $5,600Do the subsequent years through Year 6.Check calculations on the following slide.
32Check your calculations. Year 2 depreciation = $8,960Year 3 depreciation = $5,376Year 4 depreciation = $3,225.60Year 5 depreciation = $3,225.60Year 6 depreciation = $1,161.80The sum of yearly depreciations equals the total cost of the asset ($28,000).
3316.2.2 Depreciate an asset after taking a section 179 deduction For tax purposes, it can be treated as a one-time expense, rather than as a capital expenditure that is depreciated over several years.The amount that is claimed under Section 179 is subtracted from the original price of the property and the balance can be depreciated using any of the approved methods of depreciation.Eligible only in the first year that a qualifying property is purchased and placed into service.
34Section 179 DeductionProperty must be placed in service for business purposes only. A property put in service first for personal use and subsequently for business use would not be eligible.Eligible property, in general, is tangible, depreciable personal property that is used for the production of income.Can only be used to reduce taxable income, not to create a net loss; estates and trusts cannot claim the Section 179 deduction.
35How to depreciate an asset after taking a Section 179 deduction Decide how much of the maximum section 179 allowance to apply to the asset.Subtract the elected section 179 deduction from the total cost of the asset.Apply an approved depreciation method to the value from the previous step, instead of the actual total cost.
36Look at this exampleFind the first year depreciation using MACRS for the 7th Inning’s kitchen, that is purchased and placed into service at midyear. The price of the property is $125,250 and the maximum $100,000 section 179 deduction is elected.$125,250-$100,000 = $25,250$25,250 x 14.29% (MACRS rate) = $3,608.23The first year’s depreciation is $3,