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17-2 Chapter 17 Depreciation McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

17-3 Explain the concept and causes of depreciation Prepare a depreciation schedule and calculate partial-year depreciation Depreciation #17 Learning Unit Objectives Concepts of Depreciation and the Straight-Line Method LU17.1

17-4 Explain how use affects the units-of- production method Prepare a depreciation schedule Depreciation #17 Learning Unit Objectives Units-of-Production Method LU17.2

17-5 Explain how to use the fraction in the sum-of-the-years’-digits method Prepare a depreciation schedule Depreciation #17 Learning Unit Objectives Sum-of-the-Years’-Digits Method LU17.3

17-6 Explain the importance of residual value in the depreciation schedule Prepare a depreciation schedule Depreciation #17 Learning Unit Objectives Declining-Balance Method LU17.4

17-7 Explain the goals of ACRS and MACRS and their limitations Calculate depreciation using the MACRS guidelines Depreciation #17 Learning Unit Objectives Modified Accelerated Cost Recovery System (MACRS) with Introduction to ACRS LU17.5

17-8 Estimated Useful Life - Number of years or time periods for which the company can be use the asset Depreciation - An estimate of the use or deterioration of an asset Asset Cost - Amount paid for an asset including freight charges Concept of Depreciation Accumulated Depreciation - The total amount of the asset’s depreciation taken to date

17-9 Residual Value (Salvage Value) - Expected cash value at the end of an assets useful life. Concept of Depreciation Book Value - The unused amount of the asset cost that may be depreciated in future accounting periods Book Value = Asset cost - Accumulated Book value Book value cannot be less than residual value

17-10 Causes of Depreciation Product ObsolescencePhysical Deterioration

17-11 Straight-Line Method Distributes the same amount of expense to each period of time Depreciation expense = Cost - Residual value each year Estimated useful life in years Sam’s delivery company buys a new truck to make deliveries. The truck cost $20,000, the estimated useful life is 5 years. After 5 years the residual value is $1,000. Calculate depreciation expense and complete a depreciation schedule. $20,000 - $1,000 = $3, % = 100% = 20% # of yrs. 5

17-12 Depreciation Schedule Book value at end DepreciationAccumulatedof year (Cost - End of Cost ofexpense fordepreciationAccumulated year equipment yearat end of yeardepreciation) 1 $20,000$3,800$ 3,800$16,200 2 $20,000$3,800$ 7,600$12,400 3 $20,000$3,800$11,400$ 8,600 4 $20,000$3,800$15,200$ 4,800 5 $20,000$3,800$19,000$ 1,000 Equals Residual Value

17-13 Depreciation for Partial Years Assume Sam’s Delivery bought the truck August 10th. What would be depreciation for t he first year? Depreciation expense = Cost - Residual value each year Estimated useful life in years $20,000 - $1,000 = $3,800 x 5 = $ th Rule Aug, Sept., Oct., Nov., & Dec.

17-14 Units-of-Production Method Depreciation determined by how much the company uses the asset Depreciation expense = Cost - Residual value per unit Total estimated units produced Sam’s delivery company buys a new truck to make deliveries. The truck cost $20,000, the estimated useful life is 100,000 miles. After 5 years the residual value is $1,000. Calculate depreciation expense and complete a depreciation schedule. Depreciation = Unit x Units amount depreciation produced

17-15 Depreciation Schedule DepreciationAccumulated Book value End of Cost ofUnitsexpense fordepreciation at end year equipmentprod. yearat end of year of year 1 $20,00020,000 $3,800$ 3,800$16,200 2 $20,00015,000 $2,850$ 6,650$13,350 3 $20,00025,000 $4,750$11,400$ 8,600 4 $20,00022,000 $4,180$15,580$ 4,420 5 $20,00018,000 $3,420$19,000$ 1,000 $20,000 - $1,000 = $.19 per unit 100,000 15,000 x $.19

17-16 Sum-of-the-Years’ Digits Method Accelerated depreciation method which computes more depreciation expense in the early years of the asset’s life Depreciation = (Cost - Residual value) x Remaining life expense Sum-of-the-Years’ Digits Sam’s delivery company buys a new truck to make deliveries. The truck cost $20,000, the estimated useful life is 5 years. After 5 years the residual value is $1,000. Calculate depreciation expense and complete a depreciation schedule. Sum of the asset’s service life =15 or N(N+1) = 5(5+1) = 30 =

17-17 Depreciation Schedule DepreciationAccumulated Book value End of Cost - Fraction expense fordepreciation at end year Res. Value for year yearat end of year of year 1 $19,0005/15 $6,333.33$6,333.33$13, $19,0004/15 $5,066.67$11,400$8,600 3 $19,0003/15 $3,800$15,200$4,800 4 $19,0002/15 $2,533.33$17,733.33$2, $19,0001/15 $1,266.67$19,000$1,000 $19,000 x 4 15 $20,000 - $1,000 = $19,000

17-18 Rate = 100% x 2 = 40% 5 years Sam’s delivery company buys a new truck to make deliveries. The truck cost $20,000, the estimated useful life is 5 years. After 5 years the residual value is $1,000. Calculate depreciation expense and complete a depreciation schedule. Depreciation expense = Book value of equip. x Depreciation each year at beginning of year rate Accelerated method which computes more depreciation expense in the early years of the asset’s life. Uses up to twice the straight-line rate Declining-Balance Method

17-19 Depreciation Schedule Accumulated Book value at DepreciationAccumulated Book value End of Cost of depreciation beginning expense fordepreciation at end year Truck at beg. of year of year yearat end of year of year 1 $20,000 0 $20,000 $8,000 $ 8,000 $12,000 2 $20,000$ 8,000 $12,000 $4,800 $12,800$7,200 3 $20,000$12,800 $ 7,200 $2,880 $15,680$4,320 4 $20,000$15,680 $ 4,320 $1,728 $17,408$2,592 5 $20,000$17,408 $ 2,592 $1, $18,444.80$1,555.20* $12,000 x.40 Rate = 100% x 2 = 40% 5 years *Since we do not reach the residual value of $1,000 another $ could have been taken as depreciation expense to bring it to the estimated residual value of $1,000

17-20 Modified Accelerated Cost Recovery System (MACRS) with Introduction to (ACRS) Federal tax laws state how depreciation must be taken for income tax purposes Provides users with tables giving the useful lives of various assets and the depreciation rates

17-21 Key points of MACRS 1. It calculates depreciation for tax purposes. 2. It ignores residual value. 3. Depreciation if the first year (for personal property) is based on the assumption that the asset was purchased halfway through the year. (A new law adds a midquarter convention for all personal property if more than 40% is placed in service during the last 3 months of the taxable year.) 4. Classes 3,5,7, and 10 use a 200% declining-balance method for a period of years before switching to straight-line depreciation. You do not have to determine the year in which to switch since Table 17.6 builds this into the calculation. 5. Classes 15 and 20 use a 150% declining-balance method before switching to straight-line depreciation. 6. Classes 27.5 and 31.5 use straight-line depreciation.

17-22 Table Modified Accelerated Cost Recovery System (MACRS) Class recovery Period (life)Asset types 3-yearRacehorses more than 2 years old or any horse other than a racehorse that is more than 12 years old at the time place into service special tools of certain industries. 5-yearAutomobiles (not luxury) taxis; light general purpose trucks; semiconductor manufacturing equipment computer-based telephone central-office switching equipment qualified technological equipment; property used in connection with research and experimentation. 7-yearRailroad track single-purpose agricultural (pigpens), or horticultural; structures; fixtures; equipment; furniture. 10-yearNew law doesn’t add any specific property under this class. 15-yearMunicipal wastewater treatment plants; telephone distribution plants and comparable equipment used for two-way exchange of voice and data communications. 20-yearMunicipal sewers yearOnly residential property yearOnly nonresidential real property.

17-23 Table Annual Recovery for MACRS

17-24 Depreciation Schedule DepreciationAccumulatedBook value End of Cost ofexpense fordepreciation at end year equipment yearat end of year of year 1 $20,000$4,000$4,000$16,000 ($20,000 x.20) 2 $20,000$6,400$10,400$9,600 ($20,000 x.32) 3 $20,000$3,840$14,240$5,760 4 $20,000$2,304$16,544$3,456 5 $20,000$2,304$18,848$1,152 6 $20,000$1,152$20,000$ 0