1. CTC 475 Review
Cost Estimates

2. CTC 475
Depreciation

3. Objectives
Know the historical (SL, DB, SYD) and MACRS methods to determine book values and depreciation

4. Tax Concepts Taxes affect cash flows Depreciation affects taxes
Depreciation method is determined by law:
Post ’86-MACRS (Modified Accelerated Cost Recovery System)
’81-’86 ACRS (Accelerated Cost Recovery System)
Pre ’81-other methods (SL, DB, SYD)
SL-straight line; DB-declining balance; SYD-sum of the year’s digits

5. Depreciable Property 3 Requirements
Must be used in business or held for the production of income
Life can be determined and is longer than one year
Must be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes

6. Depreciable Property Tangible (machines, cars, computers)
Intangible (copyrights, franchises)
Real (erected on land, growing on land, attached to land; however, land itself is not depreciable)
Personal (machines, cars)
Most depreciable property is tangible, personal

7. Adjusted Cost Basis Cost of property + Cost of additions +
Installation cost

8. Book Value
The worth of a depreciable property as shown on the accounting records

9. Recovery Period Time over which cost basis can be recovered
For MACRS law sets as
3,5,7,10,15, or 20 (for tangible property)
27.5 (for residential real property)
31.5/39 years (for nonresidential real property)
Refer to Table 12.2 (MACRS depletion rates) and Table 12.4 (Example recover periods)
The recovery period is usually shorter than the actual physical life

10. Examples 3-year property 5-year property 7-year 10-year property
Tractor units, special tools, race horses
5-year property
Autos, buses, computers, office machinery
7-year
Office furniture, theme/amusement park assets
10-year property
Vessels, tugs, assets used in petroleum refining
15-year property
Sewage treatment plants, sidewalks, roads, drainage facilities bridges, fencing, landscaping, transmission lines
20-year property
Farm buildings

11. Depreciation Methods SL-straight line DB-declining balance
SYD-Sum of the years digits
MACRS, modified accelerated cost recovery system

12. Depreciation Methods-Example
7-year property
Basis is $100K
SV=0

13. SL Example Depreciation is 1/7 (14.28%) * Cost Basis
14.28% * $100K = $14,286

14. Straight Line Method EOY Depreciation Book Value - $100K 1 $14,286-
$100K 1
$14,286
$85,714 2
$71,428 3
$57,142 4
$42,856 5
$28,570 6
$14,285 7

15. What’s Wrong with this Method?

16. DB Example Cost Basis is $100K Depreciable Life is 7 years 200% DB----
Depreciation is 2/7 (28.56%) * Book Value of previous year
150% DB----(not used for this example)
Depreciation would be 1.5/7 * Book Value of previous year

17. Declining Balance Method
EOY
Depreciation
Book Value -
$100K 1
28.56%*$100K=$28,560
$71,440 2
28.56%*$71,440=$20,403
$51,036 3
28.56%*$51,036=$20,403
$36,460 4
28.56%*$36,460=$10,413
$26,047 5
28.56%*$26,047=$7,439
$18,608 6
28.56%*$18,608=$5,314
$13,294 7
28.56%*$13,294=$3,797
$9,497

18. What’s Wrong with this Method?

19. SYD Example Cost Basis is $100K Depreciable Life is 7 years
Number the depreciable life years in reverse order
Sum up the numbers
Year/Sum=Depreciation Amount applied to cost basis

20. SYD Method Year Reverse Order Depreciation Rate 1 7 7/28=25% 2 6
6/28=21.4% 3 5
5/28=17.8% 4
4/28=14.3%
3/28=10.7%
2/28=7.1%
1/28=3.5%
Sum=28
Sum=100%

21. SYD Method EOY Depreciation Book Value - $100K 1 $25,000 $75,000 2-
$100K 1
$25,000
$75,000 2
$21,428
$53,572 3
$17,857
$35,715 4
$14,286
$21,429 5
$10,714
$10,715 6
$7,143
$3,572 7

22. MACRS 3,5,7,10 yr (200% DBSLH) 15, 20 yr (150% DBSLH)
DBSLH (Declining Balance switching to Straight-Line depreciation at the optimum time with a Half-year convention)
See table 12.2 for depreciation rates which are multiplied by the cost basis
Note that the half-year convention extends depreciation rate one year beyond the recovery period (ex 4 vs 3 year)

23. MACRS Method EOY Depreciation Book Value - $100K 1-
$100K 1
14.29%*$100K=$14,290
$85,710 2
24.49%*$100k=$24,490
$61,220 3
17.49%*$100K=$17,490
$43,730 4
12.49%*$100K=$12,490
$31,230 5
8.93%*$100K=$8,930
$22,310 6
8.92%*$100K=$8,920
$13,390 7
$4,460 8
4.46%*$100K=$4,460 $0

25. Next lecture
Taxes
ATCF’s taking into account depreciation