Depreciation Construction Engineering 221 Economic Analysis

Depreciation Depreciation is an artificial (non-cash) accounting entry intended to capture the consumption of a capital asset over its economic life Depreciation increases after tax profit, so firms desire to depreciate assets as fast as possible (depreciation schedule has major tax implications)

Depreciation Depreciation basis is that part of the asset’s purchase price that is spread over the depreciation period (service life). Depreciation basis is cost minus expected salvage value at the end of the service period IRS regulations spell out the types of depreciation schedules and bases for most business assets.

Depreciation Depreciation methods –Straight line D = C-S/n –Constant percentage (same as straight line except a percentage is used- may be better for hours on an turbine, for example) –Double declining balance D 1 = 2C/n, D j = 2(C-sum D m, 1,j-1 )/n –Sum-of the-years’ digits (SOYD) T=1/2*n*(n+1); D j = (c-s)(n-j+1)/T

Depreciation Statutory depreciation –Accelerated cost recovery schedules (ACRS) and modified accelerated recovery schedules (MACSR) governs all depreciation on business assets put in service after –Look up the depreciation factors in the tax code and multiply: D j + C X factor for the service life of the asset

Depreciation Other methods –Production output (similar to percentage) –Sinking fund method- like a reverse mortgage- initial depreciation is low. Almost never used. –“plus interest” methods- never used. Accounts for the time-value of the money being depreciated.