1. Depreciation
Depreciation – the reduction in value of an asset. Used to reflect remaining value of an asset over its useful life.
Book Depreciation – used by corporations for internal financial accounting
Tax Depreciation – use in tax calculations in accordance to government regulations
EGR

2. Why is depreciation important?
Depreciation can lower your taxes:
taxes = (income – deductions)*tax rate
where one of the primary deductions is depreciation.
In other words, the use of depreciation can make you money by reducing the amount of taxes you pay.
EGR

3. Definitions
First Cost – cost of purchasing and installing an asset (on real-estate, the value of land is excluded)
Book Value – the remaining, undepreciated capital of an asset which is on the corporation’s books; the first cost minus the sum of all deprecation taken
Recovery Period – depreciable life of the asset in years
Market Value – estimate of the value of an asset if sold on the open market, not necessarily the same as the book value.
EGR

4. Definitions
Depreciation Rate – the fraction of the “First Cost” removed by depreciation each year.
Personal Property – allowed for depreciation, includes items such as manufacturing equipment, vehicles, computers, etc.
Real Property – also allowed for depreciation, includes office buildings, warehouses, manufacturing facilities, etc… note, land is not depreciated.
Half-year convention – assumes assets are placed in service in midyear.
EGR

5. Straight Line (SL) Depreciation
Book value depreciates linearly with time. In other words, depreciation is removed in equal amounts each year.
Where t = year (1,2,… n)
Dt = annual depreciation charge
B = first cost
S = estimated salvage value
n = recovery period
d = depreciation rate = 1/n
EGR

6. SL Depreciation Book value (SL): Depreciation rate is constant:
EGR

7. SL Depreciation
Example: A $20,000 vehicle is to be depreciated over 7 years using SL depreciation.
Dt = 20000/7 = 2857
d = 1/n = 1/7 =
EGR

8. Depreciation Straight Line (SL) Depreciation
Example: What would the yearly depreciation and depreciation rate be if the $20,000 vehicle is expected to have a salvage value of $6,000?
Dt = _____________
d = ______________
Dt = ( )/7 = 2000
d = 1/n = 1/7 =
EGR

9. Declining Balance (DB) Depreciation
Book value depreciates by a fixed percentage of the book value, not a fixed amount.
Where t = year (1,2,… n)
BVt-1 = book value in year t - 1
Dt = depreciation amount in year t
d = depreciation rate
EGR

10. DB Depreciation
Book value (DB):
EGR

11. DB Depreciation
Example: A $20,000 vehicle is to be depreciated over 7 years using DB depreciation with a depreciation rate of 0.25.
NOTE: BV IN YEAR 7 IS THE IMPLIED SALVAGE VALUE
EGR

12. Double Declining Balance (DDB) Depreciation
The maximum annual depreciation rate for DB method is:
dmax = 2/n
In this case, the method is called double declining balance (DDB)
EGR

13. Modified Accelerated Cost Recovery System (MACRS)
MACRS is the US government accepted depreciation schedule for tax purposes. MACRS combines facets of DDB and SL methods.
Assets are grouped into categories based on recovery periods of 3, 5, 7, 10, 15, 20, 27.5, and 39 years.
See table 16-4, pg. 546 for asset groupings.
Examples:
landscaping around the UC
rental house
tooling for new line of refrigerators
NOTE: MACRS COMBINES DDB WITH SL, SWITCHES AT A TIME THAT MAXIMIZES THE PV OF THE DEPRECIATION.
EGR

14. MACRS
To determine the amount of deprecation each year, use the following depreciation rate table (table 16-2, pg. 542.)
NOTE: DEPRECIATION FOR EACH RECOVERY PERIOD RANGE LASTS FOR n+1 YEARS. (THE FIRST YEAR IS ALSO ½ OF WHAT DDB WOULD GIVE YOU) THIS IS BECAUSE OF THE HALF YEAR CONVENTION
EGR

15. MACRS
Example: A $20,000 vehicle is to be depreciated for tax purposes.
Asset recovery period = 5 years (table 16-4, pg 546)
Percentages from table 16-2
EGR