Depreciation, 5

8/10/2019 Depreciation, 5

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Business Math, Eighth EditionCleaves/Hobbs

2009 Pearson Education, Inc. Upper Saddle River, NJ07458 All Rights Reserved

16.1 Depreciation Methods forFinancial Statement Reporting

Depreciate an asset and prepare adepreciation schedule

using the straight-line method

using the units-of-production method

using the sum of the years digitsmethod

Using the declining balance method


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Key Terms

Assets: properties owned by the business,including anything of monetary value and

anything that can be exchanged for cash orother property.

Estimatedlifeor useful life: the number ofyears an asset is expected to be useable.

Salvage value, scrap value,or residualvalue: an estimated dollar value of an asset atthe end of the assets estimated life.


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Depreciation: the amount an asset decreases in valuefrom its original cost.

Straight-line depreciation: a method of depreciationin which the amount of depreciation of an asset isspread equally over the number of years of useful life ofthe asset.

Total cost: the cost of an asset including shipping andinstallation charges.

Depreciable value: the cost of an asset minus thesalvage value.

Key Terms


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16.1.1. Use the Straight LineDepreciation Method

Find the total cost of the assetTC = cost + shipping + installation

Find the depreciable valueDepreciable value = TCsalvage value

Find the yearly depreciation:= depreciable value years of expected life


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Look at this example Use the straight-line method to find the yearly

depreciation for a plating machine that has anexpected useful life of 5 years. The platingmachine cost $27,300; its shipping costs totaled$250, installation charges came to $450 and itssalvage value is $1,000.

TC= $27,300 + $250 + $450 = $28,000

Depreciable value = $28,000 - $1,000 =$27,000

Yearly depreciation=$27,000 5 = $5,400


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Try this example

A labeling machine cost $43,000.Installation costs totaled $1,250 and

shipping costs totaled $2,250. It has anexpected useful life of 10 years. Its salvagevalue is $2,000. Use the straight-linemethod of depreciation to find the yearly

depreciation for the labeling machine.

The depreciation is $4,450 per year


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Depreciation schedule: a table showing theyears depreciation, the accumulateddepreciation, and the end-of-year book value.

Accumulated depreciation: the current yearsdepreciation plus all previous yearsdepreciation.

End-of-year book value: total cost minusdepreciation for the first year. Thereafter, it isthe previous years end-of-year book valueminus the current years depreciation.

Key Terms


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16.1.2 Units-of-Production Method

Takes into account an assets use in terms of

production, for example:

Items produced

Miles driven

Hours operated

Number of times it has performed a specific

operationCompanies that use this method internallyoften adjust to a method acceptable by the

IRS for tax-reporting purposes


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Find the unit depreciation

Unit depreciation =

Depreciable value

Units produced during expected life

Depreciation for units produced

= unit depreciation x units produced


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Find the depreciation

Unit depreciation = depreciable value unitsproduced during expected life

Unit production = $27,000/ 50,000,000

Unit depreciation = $0.00054

Depreciation for 2,125,000 labels

= $0.00054 x 2,125,000 = $1,147.50

The depreciation for that number of labels is$1,147.50.


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Try this example

A small pickup truck was purchased foroccasional deliveries during the busy season ofEager Enterprises. Total cost of the truck was

$24,000. The salvage value is $2,500. Theexpected number of miles to be driven over thetrucks useful life is 100,000. Find thedepreciation after one year is the truck has

been driven 3,000 miles.

$645 is the depreciation amount


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16.1.3 Sum-of-theYearsDigits Method

Sum-of-the-years digit method: Adepreciation method which allow the greatest

depreciation the first year and decreasingamount each year thereafter.

Years depreciation rate: the depreciation rate

for any given year of a depreciation schedule.


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Find the years depreciation

The numeratorof the years depreciation rateis the number of years of expected liferemaining.

The denominatorof the years depreciationrate is the sumof the numbers from 1 to theyears of expected life.

Shortcut for finding the sum:n(n+1) = sum

2


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Depreciation schedule

Year 1= $27,000 x 5/15 = $9,000End of year book value = $28,000-$9,000=$19,000

Year 2= $27,000 x 4/15 = $7,200

End of year book value = TCaccumulateddepreciation = $11,800

Now, calculate the depreciation and book value forYears 3, 4, 5.

Y 3 $5,400 and end-of year book value is $6,400.Y 4 $3,600 and end-of year book value is $2,800.Y 5 $1,800 and end-of year book value is $1,000.


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16.1.4 Declining BalanceMethod of Depreciation

A depreciation method that provides for largedepreciation in the early years of the life of anasset.

Double-declining rate(or 200% declining-balance method): a declining balancedepreciation that is twice the straight-linedepreciation.

150% declining rate: a common decliningbalance rate that is 1 times the straight linerate.


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Find the depreciation

Yearly double declining rate= yearly straightline depreciation rate x 2

Yearly 150% declining depreciation rate=yearly straight line depreciation rate x 1.5

First years depreciation= total cost x yearlydepreciation rate

For all other years: Years depreciation =previous end-of-year book value x yearlydepreciation rate.


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Look at this example

An ice-cream freezer has a useful life of sixyears. Find the yearly:

straight line rate expressed as a decimal anda percent

Double-declining rate expressed as a

decimal and a percent. 150%-declining rate expressed as a decimal

and a percent.


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The rates

Straight-line = 1/6 or .1667 or 16.67%

Double-declining = 2(1/6) = 1/3 or 33%

150% declining rate = 1.5 (1/6) = 0.25 or 25%


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Tip!

In declining-balance depreciation, thedepreciation for the first year is based on thetotal cost of the asset.

Do not subtract the salvage value from the totalcost to find the depreciation in the first year.

The end-of-year book value for any year

cannotdrop below the salvage value of theasset. If the depreciation would cause it to dropbelow the salvage value, the years endingvalue will be the salvage value.


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A packaging machine costing $28,000 with anexpected life of five years and a resale value of$1,000 is depreciated by the declining balance

method at twice the straight-line rate. Preparea depreciation schedule.

Year one (2) x 1/5 = 2/5 or 40% or .40

$28,000 x 40% = $11,200

End of year 1 book value = TCdepreciation

End of year 1 = $28,000- $11,200 = $16,800


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Finish the depreciation schedule

Year Two= previous end-of-year bookvalue x double-declining rate

$16,800 x 0.4 = $6,720

End-of-year Two book value=previous end-of-year book value

depreciation = $16,800 - $6,720 = $10,080

(go to next slide)


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Years 3, 4 and 5

Year Three=previous end-of-year book value x double-declining rate = $10,080 x 0.4 = $4,032

End-of- year Threebook value= $10,080 - $4,032 = $6,048

Year Four depreciation = $2,419.20End of year Fourbook value = $3,628.80

Year Five depreciation = $1,451.52End-of-year Fivebook value = $2,177.28


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16.2 DepreciationMethods for IRS Reporting

Depreciate an asset and prepare adepreciation schedule using the modifiedaccelerated cost-recovery system(MACRS)

Depreciate an asset after taking a section179


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16.2.1 Using MACRS

In, 1981, the IRS enacted an accelerated cost-recovery system (ACRS) for the depreciation ofproperty put into service after that date.

Allowed businesses to write off cost of assetsmore quickly.

Objective was to encourage businesses toinvest in more assets despite an economicslowdown at the time.


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Table 16-5

Table 16-5 indicates that each recovery periodhas a depreciation rate for one year more thanthe recovery period indicates.

First and last year in the recovery period arepartial years.

Greatest amount of depreciation is realized inthe second year, which is the first full year.


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Using the MACRS Method

Using the IRS publication, determine theassets recovery period and find theappropriate table.

Find the MACRS rate using Table 16-5

Multiply the years MACRS rate by the totalcost of the asset.

Years Depreciation =Years MACRS rate x total cost


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Why is this easier than traditionaldepreciation methods?

1. You do not have to find a depreciablevalue.

2. You do not have to determine a salvagevalue.

3. The useful life is determined by theproperty classes.


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Find the depreciation for each year for a boilerthat was purchased for $28,000 and placed inservice at midyear under the MACRS method of

depreciation as a five-year property. Year 1 depreciation = MACRS rate x Total Cost

Year 1 depreciation = 20% x $28,000

Year 1 depreciation = $5,600 Do the subsequent years through Year 6.

Check calculations on the following slide.


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Check your calculations.

Year 2 depreciation = $8,960

Year 3 depreciation = $5,376

Year 4 depreciation = $3,225.60



The sum of yearly depreciations equals the totalcost of the asset ($28,000).


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16.2.2 Depreciate an Asset AfterTaking a Section 179 Deduction

For tax purposes, it can be treated as a one-time expense, rather than as a capitalexpenditure that is depreciated over severalyears.

The amount that is claimed under Section 179is subtracted from the original price of theproperty and the balance can be depreciated

using any of the approved methods ofdepreciation.

Eligible only in the first year that a qualifyingproperty is purchased and placed into service.


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Section 179 Deduction

Property must be placed in service forbusinesspurposesonly. A property put inservice first for personal use and subsequently

for business use would not be eligible.

Eligible property, in general, is tangible,depreciable personal property that is used forthe production of income.

Can only be used to reduce taxable income,not to create a net loss; estates and trustscannot claim the Section 179 deduction.


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How to depreciate an asset aftertaking a Section 179 deduction

Decide how much of the maximum section 179allowance to apply to the asset.

Subtract the elected section 179 deduction fromthe total cost of the asset.

Apply an approved depreciation method to the

value from the previous step, instead of theactual total cost.


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B i M h Ei h h Edi i


Find the first year depreciation using MACRSfor the 7thInnings kitchen, that is purchasedand placed into service at midyear. The price ofthe property is $125,250and the maximum$100,000 section 179 deduction is elected.

$125,250-$100,000 = $25,250

$25,250 x 14.29% (MACRS rate) = $3,608.23

The first years depreciation is $3,608.2336

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Depreciation, 5