1. OUTLINE
Questions?
News?
Depreciation
Taxes

3. DEPRECIATION METHODS
DEPRECIATION IS CALCULATED TWO WAYS, EACH WITH ITS OWN PURPOSES
BOOK DEPRECIATION
FINANCIAL REPORTS
INCOME STATEMENTS
REFLECTS ACTUAL LOSS IN VALUE
STATE TAXES AND FEDERAL TAXES BEFORE 1981
TAX DEPRECIATION
TO CALCULATE TAXES FOR THE IRS
TAKES ADVANTAGE OF TAX RULES
USUALLY LEADS TO BETTER CASH POSITION IN EARLIER YEARS

4. BOOK DEPRECIATION METHODS
STRAIGHT LINE (SL)
ACCELERATED
DECLINING BALANCE (DB)
DECLINING BALANCE WITH CONVERSION TO SL
UNIT OF PRODUCTION
DEPLETION

5. DECLINING BALANCE METHOD
USES A FIXED FRACTION (alpha) OF THE BEGINNING BOOK BALANCE EACH YEAR:
MULTIPLIERS:
1.5 OR 150% DB
2.0 OR 200% OR DOUBLE DECLINING METHOD (DDB)

6. DECLINING BALANCE WITH CONVERSION TO STRAIGHT LINE
WHAT DO WE DO IF THE DB METHOD DOES NOT RESULT IN THE ESTIMATED SALVAGE VALUE?
1. IF BN > S
WE HAVE NOT DEPRECIATED THE ASSET FULLY
SWITCH TO STRAIGHT LINE THE FIRST YEAR THAT THE STRAIGHT LINE DEPRECIATION IS GREATER THAN THE DB METHOD
2. BN < S
STOP DEPRECIATING WHEN YOU GET TO S
EXAMPLES 9.3 AND 9.4

7. Example 9.3
Cost basis of the asset I = $10,000
Useful life N = 5 years
Estimated salvage value S = $2,000

8. Example 9.4 –Declining Balance
Cost basis of the asset I = $10,000
Useful life N = 5 years
Estimated salvage value, S = $778
D1 =

9. Changing to straight line
WE DID NOT DEPRECIATE THE ASSET FULLY AND MUST SWITCH TO STRAIGHT LINE

10. UNITS - OF - PRODUCTION METHOD
ALLOCATES THE DEPRECIATION IN PROPORTION TO THE UNITS PRODUCED AS A FRACTION OF THE TOTAL UNITS
EXAMPLE 9.7

11. HISTORY OF DEPRECIATION METHODS
UNTIL STRAIGHT LINE ONLY
ADDED ACCELERATED METHODS:
DECLINING BALANCE (DB)
DOUBLE DECLINING METHOD (DDB)
SUM OF THE YEARS’ DIGITS (SOYD) (WE DO NOT COVER)
1981
REPLACED BY ACCELERATED COST RECOVERY SYSTEM (ACRS)
1986 MODIFIED ACRS = MACRS
2017 SOME MODIFICATIONS

12. MODIFICATIONS
$1000 TO $2500
Bonus in year of acquisition
$1M per item, $2.M max (sometimes quoted half that – we will us the larger amount
Survey only, not tax advice – always use a tax specialist if you are in business
Also extra 50% in first year for eligible equipment
We will assume all equipment is eligible
We will assume all buildings as 39 year life
Modifications to buildings are eligible

13. MODIFIED ACCELERATED RECOVERY SYSTEM (MACRS)
SALVAGE VALUE ALWAYS ZERO
RECOVERY PERIOD -- ARBITRARY LIFE FOR THE INVESTMENT, NOT NECESSARILY EQUAL TO ACTUAL LIFE
EIGHT CATEGORIES: 3, 5, 7, 10, 15, 20, 27.5, 39 YEARS
3, 5, 7 AND 10 YEARS - USE 200%DDB, SWITCH TO SL
15 AND 20 YEARS -- USE 150%DDB AND SWITCH TO SL
27.5 YEARS RESIDENTIAL RENTAL -- SL
39 YEARS COMMERCIAL BUILDINGS -- SL
USE TABLE 9.3 ON PAGE 448

16. MACRS TABLE

19. HALF YEAR CONVENTION
FOR EQUIPMENT PLACED IN SERVICE USING MACRS:
ALL ASSETS ARE ASSUMED TO BE PLACED IN SERVICE IN THE MIDDLE OF THE YEAR (some change here that we will ignore)
ALL SALVAGE VALUE IS ZERO
ONLY A HALF YEARS’ DEPRECIATION IS ALLOWED THE FIRST YEAR
THE REMAINING HALF YEAR IS ALLOWED FOLLOWING THE END OF THE RECOVERY PERIOD
FOR REAL PROPERTY, USE MID - MONTH INSTEAD OF HALF YEAR

20. EXAMPLE 9.8
ASSET = $10,000 MACRS CLASS 5 YEARS

21. DEPLETION APPLIES TO NATURAL RESOURCES
OBJECTIVE IS THE SAME AS DEPRECIATION
COST DEPLETION WORKS JUST LIKE UNITS OF PRODUCTION - EQUATION 9.9:
COST DEPLETION =(ADJUSTED BASIS OF MINERAL PROPERTY)x(NUMBER OF UNITS SOLD) / (TOTAL NUMBER OF RECOVERABLE UNITS)
EXAMPLE 9.10
PERCENTAGE DEPLETION - PORTION OF GROSS INCOME, LIMITED BY 50% OF THE TAXABLE INCOME WITHOUT THE DEPLETION
ALLOWABLE PERCENTAGES ARE GIVEN IN TABLE 9.5. THESE RANGE FROM 5% TO 22%
EXAMPLE 9.11

22. Cost depletion vs. percentage depletion

23. REPAIRS OR IMPROVEMENTS
For tax depreciation purposes, repairs or improvements made to any property are treated as separate property items.
The recovery period for a repair or improvement to the initial property normally begins on the date the repaired or improved property is placed in service.
The recovery class of the repair or improvement is the recovery class that would apply to the property if it were placed in service at the same time as the repair or improvement.
Example 9.12 (modified)

24. EXAMPLE 9.12
In January 2004, Kendall Manufacturing Company purchased a new numerical control machine at a cost of $60,000. The machine had an expected life of 10 years at the time of purchase and a zero expected salvage value at the end of the 10 years.
For book depreciation purposes, no major overhauls had been planned over the 10-year period, and the machine was being depreciated toward a zero salvage value, or $6,000 per year, with the straight-line method.
• For tax purposes, the machine was classified as a 7-year MACRS property.

25. EXAMPLE 9.12 CONTINUED

26. EXAMPLE 9.12 CONTINUED
In December 2006, however, the machine was thoroughly overhauled and rebuilt at a cost of $15,000. It was estimated that the overhaul would extend the machine’s useful life by 5 years.

27. EXAMPLE 9.12 CONTINUED