1. Mastering Depreciation © American Institute of Professional Bookkeepers, 2010 Mastering Depreciation American Institute of Professional Bookkeepers

2. Mastering Depreciation Business-related Assets The categories of business-related assets are property, plant and equipment (PP&E)  Property includes:  buildings  land  Plant and plant assets (fixed assets) are:  generally long-term (last longer than 1 year)  acquired for business use  not intended for resale to customers

3. Mastering Depreciation Slide 3 Depreciation of Plant Assets Depreciation is the periodic allocation of the cost of a tangible, long-term asset over its estimated useful life. The purpose of depreciation is to match the expense of using an asset against the revenue it produces.

4. Mastering Depreciation Slide 4 Booking Depreciation Depreciation expense is booked at the end of the period with an adjusting entry: The asset’s book value is its cost less the balance in Accumulated Depreciation Depreciation Expense Accumulated Depreciation xxx The debit recognizes the expense. The credit to Accumulated Depreciation effectively reduces the balance in the related asset account.

5. Mastering Depreciation Slide 5 Booking Depreciation There are two kinds of depreciation:  GAAP (book) depreciation—used to prepare the financial statements  Tax depreciation—used to calculate depreciation for tax purposes Tax depreciation can be used for both tax and book purposes only if:  the financial statements will not be audited, or  tax depreciation is not materially different from GAAP depreciation

6. Mastering Depreciation Slide 6 Depreciation of Plant Assets To compute depreciation of PP&E, you need to know:  The asset’s cost  The asset’s estimated residual value (also known as salvage value, scrap value or trade-in value)  The asset’s estimated useful life in years or units  The depreciation method being used

7. Mastering Depreciation Slide 7 Depreciation of Plant Assets Generally, the cost of a property or plant asset includes all costs required to acquire, transport and prepare the asset for its intended use. Cost includes (but is not limited to):  Purchase price  Transportation costs  Installation or set-up costs  Testing

8. Mastering Depreciation Slide 8 Land and Improvements to Land Land, although not depreciable, is still a company asset. Because they are part of the land’s purchase price the following costs are also not depreciable:  Brokerage commissions  Survey fees  Legal fees  Back (delinquent) property taxes  Grading/clearing  Cost of demolishing or removing buildings

9. Mastering Depreciation Slide 9 Land and Improvements to Land Improvements to land are depreciable because they are subject to decay:  Driveways, sidewalks and parking lots  Fences  Sprinkler systems  Lights in parking lot

10. Mastering Depreciation Slide 10 Buildings The cost of a building includes:  Purchase price  Brokerage commissions  Sales and other taxes  Expenditures for repairing or renovating the acquired building for its intended use

11. Mastering Depreciation Slide 11 Determining Cost Machinery or equipment costs include:  Purchase price less discounts  Purchase commissions  Transportation  Insurance in transit  Sales and other taxes  Installation  Tests before placing the asset in service

12. Mastering Depreciation Slide 12 Acquisition for Cash On January 1, AbCo purchases equipment for $60,000 cash. GENERAL JOURNAL Date DescriptionDebitCredit Jan1Equipment60,000 Cash60,000

13. Mastering Depreciation Slide 13 Acquisition for Debt On January 15, AbCo purchases a building for $40,000 cash and a $160,000 note payable. GENERAL JOURNAL Date DescriptionDebitCredit Jan15Building200,000 Cash40,000 Note Payable160,000

14. Mastering Depreciation Slide 14 Cost of Land Purchased: Example SPT purchases land for $90,000 cash and a $120,000 note payable. In addition, SPT pays:  Delinquent property taxes of $2,000  Title insurance of $2,500  $4,500 to level the land  $63,000 for a fence around the property  $10,400 for a sign near the entrance  $6,000 for lighting How should SPT record the asset?

15. SPT purchases land for $90,000 cash and a $120,000 note payable. In addition, SPT pays:  Delinquent property taxes of $2,000  Title insurance of $2,500  $4,500 to level the land  $63,000 for a fence around the property;  $10,400 for a company sign near the entrance; and  $6,000 for special lighting to the grounds. How should SPT record the asset? Mastering Depreciation Slide 15 Cost of Land Purchased: Example Part of the cost of the land

16. SPT purchases land for $90,000 cash and a $120,000 note payable. In addition, SPT pays:  Delinquent property taxes of $2,000  Title insurance costing $2,500  $4,500 for leveling the land;  $63,000 for a fence around the property  $10,400 for a company sign near the entrance  $6,000 for special lighting to the grounds How should SPT record the asset? Mastering Depreciation Slide 16 Cost of Land Purchased: Example Land improvements

17. Mastering Depreciation Slide 17 Cost of Land Purchased: Example SPT purchases land for $90,000 cash and a $120,000 note payable. In addition, SPT pays:  Delinquent property taxes of $2,000  Title insurance costing $2,500  $4,500 for leveling the land  $63,000 for a fence around the property  $10,400 for a company sign near the entrance  $6,000 for special lighting to the grounds GENERAL JOURNAL Date DescriptionDebitCredit Land219,000 Cash 79,400 Note payable 178,400 Land Improvements 120,000

18. Mastering Depreciation Slide 18 Group Purchases When two or more assets are purchased for a single price:  the cost is allocated among the individual assets  the portion of the cost allocated to each asset is calculated by dividing the fair market value (FMV) of each asset by the FMV of the group.

19. Mastering Depreciation Slide 19 Group Purchase: Example Beauty Shop pays $110,000 for a shop and the land it is on. FMV of the land$90,000 FMV of the building$60,000 How much of the purchase price should be allocated to land v. the building?

20. Mastering Depreciation Slide 20 Group Purchase: Example $90,000 $90,000 + $60,000 $60,000 $90,000 + $60,000 = 60% = 40%

21. Mastering Depreciation Slide 21 Group Purchase: Example According to this formula, the $110,000 purchase price is allocated as follows:  Land: $110,000 x 60% = $66,000  Building: $110,000 x 40% = $44,000

22. Mastering Depreciation Slide 22 Review: Depreciation of PP&E To compute depreciation of PP&E, you need to know:  The asset’s cost  The asset’s estimated residual value (or salvage value, scrap value or trade-in value)  The asset’s estimated useful life in years or units  The depreciation method being used

23. Mastering Depreciation Slide 23 Residual Value Residual value is an estimate of the value the company would recover from disposal of the asset at the end of its useful life.  The cost of the asset less the residual value is its depreciable base—the amount that can be depreciated  An asset cannot be depreciated past its residual value

24. Mastering Depreciation Slide 24 Review: Depreciation of PP&E To compute depreciation of PP&E, you need to know:  The asset’s cost  The asset’s estimated residual value (or salvage value, or scrap value or trade-in value)  The asset’s estimated useful life in years or units  The depreciation method being used

25. Mastering Depreciation Slide 25 Useful Life The useful life of a plant asset is:  The estimated years that the asset will produce or  The number of units (items, miles, etc.) that the company expects the asset to produce

26. Mastering Depreciation Slide 26 Review: Depreciation of PP&E To compute depreciation of PP&E, you need to know:  The asset’s cost  The asset’s estimated residual value (or salvage value, or scrap value or trade-in value)  The asset’s estimated useful life in years or units  The depreciation method being used

27. Mastering Depreciation Slide 27 Depreciation Methods There are four depreciation methods. 1.Straight-line (SL) 2.Units of production (UOP) 3.Double-declining balance (DDB) 4.Sum-of-the-years’ digits (SYD) Each method results in the same amount of total depreciation over the life of the asset.

28. Mastering Depreciation Slide 28 The Straight-Line (SL) Method SL depreciation expense can be computed directly: Or, SL can be computed by calculating the annual depreciation rate (a percentage) then multiplying this rate by the depreciable base: Cost – Residual value Estimated useful life = Annual depreciation expense Depreciable base 1 Estimated useful life = Annual depreciation rate

29. Mastering Depreciation Slide 29 SL Depreciation: Example PatCo purchases equipment for its business that costs $25,000. Patco estimates that the equipment will have a useful life of 6 years and a residual value of $1,000 at the end of its useful life. Cost Residual Value Estimated Useful Life = Annual Depreciation Expense 25,000 1,0006 $4,000 Each year end, PatCo records the adjusting entry: Depreciation Expense Accumulated Depreciation 4,000

30. Mastering Depreciation Slide 30 SL Depreciation: Example The balance in PatCo’s Accumulated Depreciation account will increase each year: At the end of Year 3, PatCo will report: Equipment Accumulated Depreciation 25,000 4,000Year 1 4,000Year 2 4,000Year 3 12,000 25,000 (12,000) 13,000 Equipment - At Cost Less: Accumulated Depreciation Equipment (net)

31. Mastering Depreciation Slide 31 Year of Acquisition In the year of acquisition, an asset may be depreciated for part of the year. When first-year depreciation must be prorated, GAAP allows the use of any reasonable, consistent method. One method is months:  Acquisition on or before the 15 th counts as a full month  Acquisition after the 15 th do not begin to be depreciated until the following month

32. Mastering Depreciation Slide 32 Partial-Year Depreciation: Example NewCo purchases a press: Estimated useful life5 years Cost $17,000 Residual value$ 2,000 Scenario A The press is purchased Mar. 12. Because the asset is acquired on or before the 15 th, NewCo will take depreciation for the full month First-year depreciation is 10/12 of one year (March-December) $17,000$2,000 5 = $3,000 annual depreciation $3,000 x 10/12 = $2,500

33. Mastering Depreciation Slide 33 NewCo purchases a press: Estimated useful life5 years Cost $17,000 Residual value$ 2,000 Scenario B The press is purchased July 17. Because the asset is acquired after the 15 th, NewCo will start to depreciate the asset in the following month First-year depreciation is 5/12 of one year (August-December) $17,000$2,000 5 = $3,000 annual depreciation $3,000 x 5/12 = $1,250 Partial-Year Depreciation: Example

34. Mastering Depreciation Slide 34 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Start the depreciation schedule by listing the data for company assets: what the asset is, date acquired, depreciation method, estimated useful life, depreciable base and residual value Property Equipment Vehicles Office Building Land for Office Bldg Warehouse Land for Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van

35. Mastering Depreciation Slide 35 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Land is included on the schedule even though it is not depreciated. This tracks all plant property and equipment in one place Property Equipment Vehicles Office Building Land for Office Bldg Warehouse Land for Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van Residual Value

36. Mastering Depreciation Slide 36 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Property Equipment Vehicles Totals Office Building Land for Office Bldg Warehouse Land for Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 4% 15 yrs 8 yrs 5 yrs 6 yrs 20% 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 5,000 These are the figures needed to calculate annual depreciation. For example, annual depreciation on the office building is $300,000/30 years

37. Mastering Depreciation Slide 37 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Property Equipment Vehicles Totals Office Building Land for Office Bldg Warehouse Land for Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 90,000 40,000 60,500 15,000 12,500 16,0005,000 Unless this is the first year of operation, add a column for depreciation taken before this year 4% 20%

38. Mastering Depreciation Slide 38 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Property Equipment Vehicles Totals Office Building Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 90,000 40,000 60,500 15,000 12,500 16,0005,000 These two assets are fully depreciated (accumulated depreciation = depreciable base) Land for Office Bldg Land for Warehouse 4% 20%

39. Mastering Depreciation Slide 39 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Property Equipment Vehicles Totals Office Building Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 5,000 90,000 40,000 60,500 15,000 12,500 16,000 10,000 5,000 11,000 3,000 4,000 300,000 30 75,000 15 88,000 8 18,000 6 20,000 x 20% This column is current-year depreciation Land for Office Bldg Land for Warehouse 4% 20%

40. Mastering Depreciation Slide 40 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Property Equipment Vehicles Totals Office Building Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 5,000 90,000 40,000 60,500 15,000 12,500 16,000 10,000 5,000 11,000 3,000 4,000 100,000 90,000 45,000 71,500 15,000 15,500 20,000 += += += += += Land for Office Bldg Land for Warehouse 4% 20% The last column, accumulated depreciation = all depreciation taken to date + current-year depreciation

41. Mastering Depreciation Slide 41 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Property Equipment Vehicles Totals Office Building Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 4% 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 5,000 90,000 40,000 60,500 15,000 12,500 16,000 10,000 5,000 11,000 3,000 4,000 100,000 90,000 45,000 71,500 15,000 15,500 20,000 If the asset is also used in manufacturing, then a percentage of depreciation is charged to manufacturing (80% mfg) (100% mfg) Land for Office Bldg Land for Warehouse 20%

42. Mastering Depreciation Slide 42 Depreciation for Manufacturers To review the basic JE for depreciation: But, if the asset is used in production, depreciation is recorded as a manufacturing expense (part of manufacturing overhead) Allocation of overhead is beyond the scope of this course (it is taught in manufacturing costing) Depreciation Expense Accumulated Depreciation xxx Work in Process Inventory Accumulated Depreciation xxx

43. Mastering Depreciation Slide 43 The Depreciation Schedule Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Property Equipment Vehicles Totals Office Building Warehouse Boiler Air Filter Chevy Nova Oldsmobile Delivery Van 1/5/00 11/12/72 1/1/01 7/2/03 1/1/00 11/3/04 1/14/05 SL N/A SL N/A SL 30 yrs 4% 15 yrs 8 yrs 5 yrs 6 yrs 300,000 55,000 90,000 32,000 75,000 88,000 15,000 18,000 20,000 100,000 25,000 10,000 5,000 3,000 6,000 5,000 90,000 40,000 60,500 15,000 12,500 16,000 10,000 5,000 11,000 3,000 4,000 100,000 90,000 45,000 71,500 15,000 15,500 20,000 693,000154,000324,00033,000357,000 (80% mfg) (100% mfg) Accumulated depreciation at the beginning of the year should be $324,000 2009 depreciation totals $33,000: $18,000 expense + $15,000 overhead Land for Office Bldg Land for Warehouse cost – residual value = depreciable base 20% Based on these amounts, total PP&E on the books should be $847,000

44. Mastering Depreciation Slide 44 Units of Production (UOP) The UOP method assigns a fixed amount of depreciation to each unit of output or service that the plant asset produces. To compute depreciation for per unit: To compute depreciation for the entire period, multiply the per-unit depreciation by the number of units for the period. Cost – Residual value Useful life in units Depreciable base Depreciation rate per unit =

45. Depreciation rate per unit $0.20 per mile Mastering Depreciation Slide 45 UOP Depreciation: Example ARC Inc., purchases a delivery van on January 1, 20X1 for $22,000. The van has an estimated useful life of 100,000 miles. The company expects the van to have a trade-in value of $2,000 at the end of its useful life. 22,000 100,000 2,000 Cost – Residual value Useful life in units =

46. Mastering Depreciation Slide 46 UOP Depreciation: Example Depreciation Schedule (Units of Production) DepreciationAccumulated MilesExpenseDepreciation Yr 130,000 Yr 227,000 Yr 323,000 Yr 4 20,000 $ 6,000$ 6,000 5,40011,400 4,60016,000 4,00020,000 x.20 =

47. Mastering Depreciation Slide 47 UOP Depreciation: Example Year 1 Miles = 30,000 Dec. 31, 20X1 Depreciation Expense 6,000 Accumulated Depreciation 6,000 To record one year’s depreciation expense Depreciation Expense Accumulated Depreciation 6,000

48. Mastering Depreciation Slide 48 UOP Depreciation: Example Depreciation Expense Accumulated Depreciation 5,4006,000 5,400 11,400 Year 2 Miles = 27,000 Dec. 31, 20X2 Depreciation Expense 5,400 Accumulated Depreciation 5,400 To record one year’s depreciation expense

49. Mastering Depreciation Slide 49 Year of Acquisition Under UOP, there is no need to compute partial year depreciation because this method is based on production—not time.

50. Mastering Depreciation Slide 50 The Depreciation Schedule If the van is used to deliver 2,300 cartons, the depreciation expense is 2,300 x $0.80 = $1,840 An asset being depreciated using units of production is easily shown on the depreciation schedule. The depreciation rate per unit is shown for the asset. In this case, the van is depreciated at $0.80 per carton hauled. Property Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Dodge Van6/30/09UOP.80 ctn 8,0007,0001,840

51. Mastering Depreciation Slide 51 The Declining Balance Method Declining balance (DB) is an accelerated method that yields higher depreciation in the early years and lower depreciation in later years. Generally, the DB method is used for an asset that will be more productive (generate more revenue) early in its life.

52. Mastering Depreciation Slide 52 Annual depreciation expense Net book value = × SL rate × multiple Cost – Accumulated Depreciation 1 Estimated useful life SL rate = The multiple can be: 1.25(125% declining balance) 1.5(150% declining balance) 2(double-declining balance) The Declining Balance Method

53. Mastering Depreciation Slide 53 $48,750 ??? Net book value SL rate The DB Method: Example On January 3, DabCo purchases for $65,000 cash, equipment with an estimated useful life of 8 years and a residual value of $5,000. What is depreciation expense for the first two years under the double-declining balance method? ×× Multiple $65,00012.5%2 ××= $16,250 12.5%2 ××= $12,187.50 $65,000 – $16,250

54. Mastering Depreciation Slide 54 Year-beginning Annual Accumulated Year-end Year book value Rate depreciation depreciation book value 1$65,00025%$16,250$16,250$48,750 248,75025%12,18828,43836,562 336,56225%9,14137,57927,421 427,42125% 6,85544,43420,566 520,56625%5,14149,57515,425 615,42525%3,85653,43111,569 711,56925%2,89256,3238,677 88,677N/A 3,67760,0005,000 Residual value The DB Method: Example Maximum depreciation before reaching residual value

55. Mastering Depreciation Slide 55 The Depreciation Schedule An asset being depreciated using a declining balance method is shown on the schedule as 125 DB 150 DB or DDB. This is the depreciation rate for the asset. Apparently, the warehouse has a 40-year life, and the cherry picker a 10-year life Property Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Parts Warehouse1/01/06DDB5% 320,00030,000 Cherry Picker 150 DB 6/30/09 49,919 15% 150,00030,000

56. Mastering Depreciation Slide 56 The Depreciation Schedule You’ll need these numbers to calculate the depreciation since it is based on cost (depreciable base plus residual value) less accumulated depreciation Property Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Parts Warehouse1/01/06DDB5% 320,00030,00015,00464,923 Cherry Picker 150 DB 6/30/09 49,919 15% 150,00030,000 BV = $350,000 – $49,919 = $300,081 x Rate 5% $ 15,004

57. Mastering Depreciation Slide 57 Year of Acquisition In the year of acquisition:  Calculate the full year’s depreciation  Prorate depreciation based on the period when it occurs (as under SL depreciation) For Year 2 depreciation, calculate normally using the depreciable base (the book value less Year 1 depreciation).

58. Mastering Depreciation Slide 58 Partial-Year Depreciation: Example On August 12, NewCo acquires a press for $17,000. Its estimates that the press will have an estimated life of 5 years and a $2,000 salvage value. What is Year 1 and Year 2 depreciation using 150% declining balance? Year 1 1515 $17,000 x x 1.5 = $5,100 $ 5,100 x 5/12 = $2,125 Year 2 $14,875 x x 1.5 = $ 4,462.50 1515

59. Mastering Depreciation Slide 59 The Depreciation Schedule Property Date Acquired Kind of PropertyMethod Rate or Life Depreciable Base Residual Value Depreciation In Prior Years Depreciation For the Y/E 12/31/09 Accumulated Depreciation 12/31/09 Parts Warehouse1/01/06DDB5% 320,00030,00015,00464,923 Cherry Picker 150 DB 6/30/09 49,919 15% 150,00030,00013,500 BV $180,000 x Rate 15% $ 27,000 x 6/12 = $13,500

60. Mastering Depreciation Slide 60 Sum-of-the-Years’ Digits (SYD) This method, another kind of accelerated depreciation, is rarely used today. The year-to-year decline in depreciation is typically more gradual than under the declining balance method.

61. Mastering Depreciation Slide 61 Sum-of-the-Years’ Digits (SYD) SYD depreciation expense is calculated using the following formula: Depreciation rate Depreciable base Depreciation expense x= Remaining useful life Depreciable Base Depreciation Expense x= SYD n x (n+1) 2 where “n” is the estimated useful life

62. Mastering Depreciation Slide 62 SYD Depreciation in Year 1: Example DonCo purchases for $40,000, equipment that it estimates will have a 5-year useful life and $4,000 salvage value. Remaining useful life Depreciable base Depreciation expense x= Year 1 5 $36,000$12,000 x= 15 SYD (5 x 6)/2

63. Mastering Depreciation Slide 63 SYD Depreciation in Year 2: Example Remaining useful life Depreciable base Depreciation expense x= Year 2 4 $36,000$9,600 x= 15 SYD DonCo purchases for $40,000, equipment that it estimates will have a 5-year useful life and $4,000 salvage value.

64. Mastering Depreciation Slide 64 Partial-Year SYD Depreciation Under SYD, booking a mid-year acquisition is cumbersome. Compute full year depreciation, then prorate this amount between Years 1 and 2. Depreciation in all future years must also be prorated.

65. Mastering Depreciation Slide 65 Partial Year SYD: Example On April 1, 20X7, ABC purchases for $64,000 equipment that it estimates will have a 4-year useful life and $4,000 residual value. First 12 months: 4 $60,000$24,000 x= 10 Second 12 months: 3 $60,000$18,000 x= 10 Third 12 months: 2 $60,000$12,000 x= 10 20X720X820X9 $18,000$ 6,000 13,500$ 4,500 9,000

66. Mastering Depreciation Slide 66 Tax v. Book Depreciation Book Depreciation Tax Depreciation Depreciation is a deduction from revenue on the income statement. Depreciation is a deduction from income on the tax return. Computed under GAAP. The entity can choose among various depreciation methods—including straight-line, units of production, declining balance and sum-of-the- years’-digits. Computed under Internal Revenue Code (IRC) rules. The entity is required to use MACRS depreciation.

67. Mastering Depreciation Slide 67 Tax v. Book Depreciation Book Depreciation Tax Depreciation Depreciable basis = total cost – residual value. Depreciable basis = total cost (residual is always $0). Depreciable basis is used over the company- estimated useful life. Depreciable basis is expensed over the IRS-determined recovery period. Bonus depreciation and §179 accelerate tax depreciation deductions—but automobiles have deduction limits that often reduce deductions.

68. Mastering Depreciation Slide 68 Tax Depreciation: Buildings Real property (real-estate) has different tax rules from other property. It is depreciated under MACRS using the SL method:  Commercial buildings: over 39 years  Residential buildings: over 27½ years Depreciation of real property begins in the middle of the month it is placed in service.  Example: If a building is placed in service in March, depreciation begins on March 15.

69. Use the depreciation rate in the column that corresponds to the month of the year that the property is placed in service Mastering Depreciation Slide 69 IRS Table: Residential Rental Property Year Month 123456789101112 1 3.485%3.182%2.879%2.576%2.273%1.970%1.667%1.364%1.061%0.758%0.455%0.152% 2-9 3.636% 10 3.637% 11 3.636% 12 3.637% 13 3.636% 14 3.637% 15 3.636% 16 3.637% 17 3.636% 18 3.637% 19 3.636% 20 3.637% 21 3.636% 22 3.637% 23 3.636% 24 3.637% 25 3.636% 26 3.637% 27 3.636% 28 1.970%2.273%2.576%2.879%3.182%3.485%3.636% 29 0.152%0.455%0.758%1.061%1.364%1.667% For example, to depreciate residential rental property placed in service during March, a calendar year company uses the 3 rd column Notice that it takes 28 years to fully depreciate the property using the SL method over 27½ years

70. Mastering Depreciation Slide 70 IRS Table: Residential Rental Property Year Month 123456789101112 1 3.485%3.182%2.879%2.576%2.273%1.970%1.667%1.364%1.061%0.758%0.455%0.152% 2-9 3.636% 10 3.637% 11 3.636% 12 3.637% 13 3.636% 14 3.637% 15 3.636% 16 3.637% 17 3.636% 18 3.637% 19 3.636% 20 3.637% 21 3.636% 22 3.637% 23 3.636% 24 3.637% 25 3.636% 26 3.637% 27 3.636% 28 1.970%2.273%2.576%2.879%3.182%3.485%3.636% 29 0.152%0.455%0.758%1.061%1.364%1.667% EXAMPLE On March 1, 2009, a calendar year company places in service residential rental property costing $100,000 For calendar year firms, March 15–Dec. 31 is 9½ months 1/27.5 = 3.636% x 9.5/12 = 2.879%

71. Mastering Depreciation Slide 71 IRS Table: Residential Rental Property Year Month 123456789101112 1 3.485%3.182%2.879%2.576%2.273%1.970%1.667%1.364%1.061%0.758%0.455%0.152% 2-9 3.636% 10 3.637% 11 3.636% 12 3.637% 13 3.636% 14 3.637% 15 3.636% 16 3.637% 17 3.636% 18 3.637% 19 3.636% 20 3.637% 21 3.636% 22 3.637% 23 3.636% 24 3.637% 25 3.636% 26 3.637% 27 3.636% 28 1.970%2.273%2.576%2.879%3.182%3.485%3.636% 29 0.152%0.455%0.758%1.061%1.364%1.667% EXAMPLE On March 1, 2009, a calendar year company places in service residential rental property costing $100,000. What is depreciation for 2009–2011? 2009$100,000 x 2.879%$2,879 2010$100,000 x 3.636%3,636 2011$100,000 x 3.636%3,636

72. Mastering Depreciation Slide 72 IRS Table: Nonresidential Real Property Year Month 123456789101112 12.461%2.247%2.033%1.819%1.605%1.391%1.177%0.963%0.749%0.535%0.321%0.107% 2-392.564% 400.107%0.321%0.535%0.749%0.963%1.177%1.391%1.605%1.819%2.033%2.247%2.461% There IRS requires using this table to depreciate nonresidential real property (commercial buildings, such as office buildings and warehouses)

73. Mastering Depreciation Slide 73 Tax Depreciation: Plant, Equipment Generally, IRS tables for property other than buildings—i.e., plant and equipment:  specify a 5-year or 7-year recovery period  use the DDB or SL method, and  assume the asset was placed in service in the middle of the year regardless of purchase date  Exception: Under the mid-quarter convention, when more than 40% of this type of property —§179 property—is placed in service in the last quarter of the year, depreciation begins in the middle of the quarter it is placed in service.

74. Mastering Depreciation Slide 74 Mid-Quarter Convention: Example ABC Co. (a calendar year company) places in service two assets during the year. The first was a machine that cost $21,000 (placed in service on April 9, 2009); the second was a machine that cost $15,000 (placed in service on October 5, 2009). /( + ) = 41.67% Because more than 40% of ABC’s §179 property was placed in service during the 4 th quarter, ABC will start depreciating the first machine on May 15, 2009 (middle of the 2 nd quarter) and start depreciating the second machine on November 15, 20X9 (middle of the 4 th quarter). $15,000 $21,000 $15,000

75. Mastering Depreciation Slide 75 Mid-Quarter Convention: Example ABC Co. (a calendar year company) places in service two assets during the year. The first was a machine that cost $21,000 (placed in service on April 9, 2009); the second was a machine that cost $12,000 (placed in service on October 5, 2009). /( + ) = 36.36% Because this percentage does not exceed 40%, ABC will depreciate both assets starting on July 1, 2009 (middle of the year). $12,000 $21,000 $12,000 Note: The examples for the rest of this presentation assume that 40% or less of a company’s Section 179 property is placed in service in the fourth quarter.

76. Mastering Depreciation Slide 76 Tax Depreciation: Plant, Equipment Generally, IRS tables for property other than buildings-i.e., plant and equipment:  specify a 5-year or 7-year recovery period  use the DDB or SL method, and  assume the asset was placed in service in the middle of the year regardless of purchase date  Example: For an asset with a 5-year recovery period, first-year depreciation is: 1/5 x 200% = 40% x ½ year = 20%.

77. Note that in the final year, a half year’s depreciation expense is allowed. Mastering Depreciation Slide 77 100% IRS Tables: Plant, Equipment At the end of the recovery period, the entire cost of the asset has been expensed Year 5-Year Property7-Year Property 120.00%14.29% 232.00 24.49 319.2017.49 411.5212.49 511.528.93 65.768.92 78.93 84.46 Even though the DDB method is used, Year 1 depreciation rates are lower than Year 2, because in Year 1 only a half year’s depreciation is allowed In Years 7-8, SL depreciation would be higher—under DDB, these years simply use up the remaining depreciation

78. Mastering Depreciation Slide 78 20X1 depreciation [$10,000 x 20%]$2,000 20X2 depreciation [$10,000 x 32%]3,200 20X3 depreciation [$10,000 x 19.2%]1,920 20X4 depreciation [$10,000 x 11.52%] 1,152 20X5 depreciation [$10,000 x 11.52%] 1,152 20X6 depreciation [$10,000 x 5.76%] 576 On May 22, 20X1, DiCo, a calendar year firm, acquired an asset costing $10,000. The asset has a 5-year recovery period. Using the IRS table, tax depreciation is as follows. Tax Depreciation Tables: Example

79. Year 1 depreciation is the same as it was for the asset purchased on May 22. Under MACRS, depreciation starts in the middle of the year that the property is acquired. Mastering Depreciation Slide 79 On October 11, 20X1, a calendar year company purchases for $10,000, an asset with a 5-year recovery period. Tax depreciation of the asset is as follows: Tax Depreciation Tables: Example 20X1 depreciation [$10,000 x 20%]$2,000 20X2 depreciation [$10,000 x 32%]3,200 20X3 depreciation [$10,000 x 19.2%]1,920 20X4 depreciation [$10,000 x 11.52%] 1,152 20X5 depreciation [$10,000 x 11.52%] 1,152 20X6 depreciation [$10,000 x 5.76%] 576

80. Mastering Depreciation Slide 80 Bonus depreciation:  applies to new depreciable property other than real property placed in service during 2009 and 2010  must be taken unless the company files an election not to take it  is a deduction of 50% of the asset’s cost in the first year with the remainder of the cost depreciated under MACRS Bonus Depreciation

81. Mastering Depreciation Slide 81 2009 bonus deprec. [$10,000 x 50%] $5,000 2009 MACRS deprec. [$5,000 x 20%] 1,000 2010 MACRS deprec. [$5,000 x 32%] 1,600 2011 MACRS deprec. [$5,000 x 19.2%] 960 2012 MACRS deprec. [$5,000 x 11.52%] 576 2013 MACRS deprec. [$5,000 x 11.52%] 576 2014 MACRS deprec. [$5,000 x 5.76%] 288 On May 22, 2009, a calendar year company pays $10,000 for a new asset with a 5-year recovery period. Bonus Depreciation: Example

82. Mastering Depreciation Slide 82 On May 22, 2009, a calendar year company pays $10,000 for a used asset with a 5-year recovery period. 2009 depreciation [$10,000 x 20%]$2,000 2010 depreciation [$10,000 x 32%]3,200 2011 depreciation [$10,000 x 19.2%]1,920 2012 depreciation [$10,000 x 11.52%] 1,152 2013 depreciation [$10,000 x 11.52%] 1,152 2014 depreciation [$10,000 x 5.76%] 576 Bonus Depreciation: Example

83. Mastering Depreciation Slide 83 Section 179 deductions:  apply only to depreciable property other than real property—plant and equipment  can be taken up to $250,000 for new plant and equipment acquired in 2009—but can never reduce a company’s income from its trade and business activities below $0  are reduced dollar-for-dollar when the total original cost basis of plant and equipment acquired during the year exceeds $800,000 Section 179 Deduction

84. Mastering Depreciation Slide 84 During 2009, DuCo acquires equipment (7-year property) that costs $350,000. Depreciation for 2009-2011 is as follows. 2009 Section 179 deduction$250,000 2009 MACRS [$100,000 x 14.29%] 14,290 Total 2009 depreciation expense$264,290 2010 MACRS [$100,000 x 24.49%]$ 24,490 2011 MACRS [$100,000 x 17.49%]$ 17,490 Section 179 Deduction: Example

85. Mastering Depreciation Slide 85 During 2009, a firm acquires equipment for $980,000. Because the cost exceeds $800,000, Section 179 is limited: Maximum Section 179 deduction$250,000 Total Section 179 property$ 980,000 Less: (800,000) (180,000) Maximum Sec. 179 for 2009$ 70,000 Section 179 Deduction: Example

86. Mastering Depreciation Slide 86 During 2009, a firm acquires for $980,000, used equipment with a 7-year recovery period. Total deductions for Section 179 and depreciation for 2009-2011 are: Total Deductions: Example 2009 Section 179 deduction$ 70,000 2009 MACRS [$910,000 x 14.29%] 130,039 Total 2009 depreciation expense$200,039 2010 MACRS [$910,000 x 24.49%]$222,859 2011 MACRS [$910,000 x 17.49%]$159,159

87. Mastering Depreciation Slide 87 Tax Depreciation of Vehicles  The IRC imposes limits on depreciation for certain vehicles.  Passenger autos (most vehicles weighing 6,000 lbs or less) have annual limits.  Heavy SUVs, pickups, and vans (generally, 6,000-14,000 lbs). Section 179 is limited to $25,000—but there are limits on depreciation.

88. Mastering Depreciation Slide 88 In 2009, ByCo acquires a new passenger auto costing $35,000. What is ByCo’s maximum 2009 depreciation on the auto? IRS Auto Limits: Example Depreciation is the lesser of the following:  Bonus depreciation ($35,000 x 50%) $17,500 + MACRS depreciation ($17,500 x 20%) 3,500 Total (regular) tax depreciation $21,000 - or -  The IRS passenger auto depreciation limit

89. Mastering Depreciation Slide 89 IRS Auto Limits: Example IRS depreciation limits on passenger autos purchased in 2009: Bonus depreciation Yeartaken not taken 1$10,060$2,960 24,800 32,850 4 and after1,775

90. Mastering Depreciation Slide 90 In 2009, ByCo acquires a new passenger auto costing $35,000 for which ByCo takes bonus depreciation. IRS Auto Limits: Example  The IRS passenger auto limit $10,060  Bonus depreciation ($35,000 x 50%) 7,500 + MACRS depreciation ($17,500 x 20%) 3,500 Total (regular) tax depreciation $21,000 - or - 2009 depreciation is the lesser of:

91. Mastering Depreciation Slide 91 In 2009, ByCo acquires a new passenger auto costing $35,000 for which ByCo takes bonus depreciation. 2010 depreciation is the lesser of: IRS Auto Limits: Example  MACRS depreciation ($17,500 x 32%)$5,600 - or -  The IRS passenger auto depreciation limit

92. Mastering Depreciation Slide 92 IRS Auto Limits: Example IRS depreciation limits on passenger autos purchased in 2009: Bonus depreciation Yeartaken not taken 1$10,960$2,960 24,800 32,850 4 and after1,775

93. Mastering Depreciation Slide 93 In 2009, ByCo acquires a new passenger auto costing $35,000 for which ByCo takes bonus depreciation. 2010 depreciation is the lesser of: IRS Auto Limits: Example  MACRS depreciation ($17,500 x 32%)$5,600 - or -  The IRS passenger auto limit $4,800

94. Mastering Depreciation Slide 94 In 2009, ByCo acquires a used passenger auto costing $35,000. 2009 depreciation is the lesser of: IRS Auto Limits: Example  MACRS depreciation ($35,000 x 20%) $7,000 - or -  The IRS passenger auto depreciation limit

95. Mastering Depreciation Slide 95 IRS Auto Limits: Example IRS depreciation limits on passenger autos purchased in 2009: Bonus depreciation Yeartaken not taken 1$10,960$2,960 24,800 32,850 4 and after1,775

96. Mastering Depreciation Slide 96 In 2009, ByCo acquires a used passenger auto costing $35,000. 2009 depreciation is the lesser of: IRS Auto Limits: Example  MACRS depreciation ($35,000 x 20%) $7,000 - or -  The IRS passenger auto limit $2,960

97. Mastering Depreciation Slide 97 IRS Auto Limits: Example  MACRS depreciation ($35,000 x 32%) $11,200 - or -  The IRS passenger auto depreciation limit In 2009, ByCo acquires a used passenger auto costing $35,000. 2010 depreciation is the lesser of:

98. Mastering Depreciation Slide 98 IRS Auto Limits: Example IRS depreciation limits on passenger autos purchased in 2009: Bonus depreciation Yeartakennot taken 1$10,960$2,960 24,800 32,850 4 and after1,775

99. Mastering Depreciation Slide 99 During 2009, a company places in service a used passenger auto costing $35,000. 2010 depreciation is the lesser of: IRS Auto Limits: Example  MACRS depreciation ($35,000 x 32%) $11,200 - or -  The IRS passenger auto limit $4,800

100. Mastering Depreciation Slide 100 Nonbusiness Use of Vehicles When a vehicle is driven for personal use:  a corporation can still base depreciation on 100% business use —if the value of the personal use is included in taxable wages on the employee’s W-2.  a sole proprietorship owner can take depreciation only for the business use portion.

101. Mastering Depreciation Slide 101 In 2009, a corporate car is driven 80% for business and 20% for personal use. The corporation can take 100% of the available depreciation on the car—if the value of the 20% personal use is included in taxable wages on the employee’s W-2. Nonbusiness Use: Example

102. Mastering Depreciation Slide 102 In 2009, a sole proprietor drives her car 80% for business and 20% personal use. The sole proprietor can take 100% of the available depreciation on the car for an employee’s 80% business use—if the owner includes the value of that business use on the employee’s W-2 as wages. If the owner drove the car 80% for business, only 80% depreciation can be taken. Nonbusiness Use: Example