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DEPRECIATIONchapter 11
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Basic Aspect of Depreciation
Three distinct denitions of depreciation:1. Decline in market value of an asset2. Decline in value of an asset to its owner3. Systematic allocation of the cost of an asset
divided by its depreciable life
Depreciation calculation fundamentals:
Book value = cost – depreciation chargemade
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Principles of Depreciation
alculationSi! principal depreciation methods :"# Straight-line (SL) depreciation
2. Sum-of-years Digits (SOYD) depreciation
3. Double Declining Balance (DDB)depreciation
4. eneral De!reciation System (DS)depreciation
". #nit-of-$ro%uction (#O$) depreciation
&. 'o%ie% ccelerate% *ost +eco,erySystem ('*+S) depreciation
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Principles of Depreciation
alculationP : Cost of the assetS : End-of-useful-life salvage value$ : Useful life in years
dt : Depreciation at year tDt : !ccumulated depreciation until year tBt : "oo# value at the end-of-year t
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Straight-Line Depreciation
$he simplest and best #no%n depreciation method.&n this method a constant charge is made
•
Consider the follo%ing:
Cost of theasset %&''
Depreciablelife
(
(alvage value %)'
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Straight-Line Depreciation
*ear
dt Dt
+nitialBook,alue
-nd.of.yearBook,alue
1 %"/
/
%"/
/
%&'' %)01
2 "// 002 )01 (/3
3 "// 1&3 (/3 1'2
) "// //1 1'2 20/
* "// 30' 20/ )'
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Sum-of-Years-Digits 4S5*D6
DepreciationEach year the depreciation charge e+uals a fractionof the total amount to be depreciated ," (.•
Consider the follo%ing:
Cost of theasset %&''
Depreciablelife
(
(alvage value %)'
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Sum-of-Years-Digits 4S5*D6
Depreciation
*ea
r
dt Dt
+nitialBook
,alue
-nd.of.year
Book,alue
1%2)
)%&'' %/20
2 1&3 /20 1'2
3 //1 1'2 20/
) ))( 20/ "2(
* 30' "2( )'
*ear
dt Dt
+nitialBook
,alue
-nd.of.yearBook,alue
1%2)
)%&'' %/20
2 1&3 /20 1'2
3 //1 1'2 20/
) ))( 20/ "2(
* 30' "2( )'
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Double Declining Balance
Depreciation $his method applies a constant depreciation rate tothe property/s depreciation boo# value•
Consider the follo%ing:
Cost of theasset %&''
Depreciablelife
(
(alvage value %)'
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Double Declining Balance
Depreciation *ea
rdt Dt
+nitialBook,alue
-nd.of.yearBook,alue
1 %0/'
%&'' %(1'
2 ()/ (1' 021
3 )'/ 021 "&1
) )31 "&1 ""/
* 30' ""/ )'
*ear
dt Dt
+nitialBook,alue
-nd.of.yearBook,alue
1 %0/' %&'' %(1'
2 ()/ (1' 021
3 )'/ 021 "&1
) )31 "&1 ""/
* 30' ""/ )'
Do you reali0e this method have someproblems
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DS Depreciation
rom declining balance depreciation %e #no% thatthe total amount of depreciation charge for * yearsis 34.415. (o the boo# value is 56.6) 7 84.
$his does not normally happen. &f the 9nal boo#
value had not been e+ual to the salvage value theDD" method %ould have had to be modied. $hemodi9cation is:
"# Stop further depreciation once the 7ook value
comes to e8ual to the salvage value.2# Switch from DD" to straight-line
Consider the follo%ing:Cost of the
asset%&''
Depreciablelife
(
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DS Depreciation
*eardt
DDB
dtStraight.
9ine
onvert
Decision
+nitialBook,alue
-nd.of.yearBook,alue
1%0/'
: %")1 $o %&'' %(1'
2 2"/ : "2)#( $o (1' 021
3"2
/
: &3 $o 021 "&1#1
)))#)
/; 32#2 *es " ""2#2
* . 32#2 . ""2#2 0'
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#nit-of-$ro%uction Depreciation
$his method is used in situations %here therecovery of depreciation on a particular asset ismore closely related to use than to time.
•
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#nit-of-$ro%uction Depreciation
Eample 11-11 $he e+uipment costing ;644 has been purchasedfor use in a sand and gravel pit. $he pit %ill operate* years %hile a nearby airport is being
reconstructed and paved. $hen the pit %ill be shutdo%n and the e+uipment removed and sold for;84. Compute the U
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#nit-of-$ro%uction Depreciation
*ear dt Dt
+nitialBook,alue
-nd.of.yearBook,alue
1 %30 %&'' %3")
2 21& 3") /("
3 (3" /(" 0"&
) )1) 0"& "(0
* 30' "(0 )'
*ear dt Dt
+nitialBook,alue
-nd.of.yearBook,alue
1 %30 %&'' %3")
2 21& 3") /("
3 (3" /(" 0"&
) )1) 0"& "(0
* 30' "(0 )'
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'o%ie% ccelerate% *ost
+eco,ery System 4?A
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'o%ie% ccelerate% *ost
+eco,ery System 4?A
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'o%ie% ccelerate% *ost
+eco,ery System 4?A( depreciation for real property:
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'o%ie% ccelerate% *ost
+eco,ery System 4?A
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B!C>( rates %ere computed using eneralDe!reciation System 4DS6. ith three furtherassumptions:
1. (alvage value are assumed to be ero for all assets.
2. $he rst and last years of the recovery period areeach assumed to be half-year .
3. $he declining balance rate is 2'' for 0. (. ).and "'.year property and "(' for "(. and 2'.year property.
here ?A
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or eample consider a *-year B!C>( property asset:
*ear
DDBcalculation
S9calculation
?A
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omparing ?A( G &nternal >evenue (ervice
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omparing ?A
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Depletion
Depletion is the ehaustion of natural resourcesas a result of their removal. (ince depletion coverssuch things as mineral properties oil and gas %ellsstanding timber removal may ta#e form of digging
up metallic or nonmetallic minerals producingpetroleum or natural gas from %ells or cuttingdo%n trees.
Two distinct methods of calculating depletion :
–
*ost Depletion – $ercentage Depletion
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*ost Depletion
Depreciation relied on an assetHs costdeprecia7le life and salvage value to apportionthe cost minus salvage value over the depreciablelife. &n some cases %here the asset is used atLuctuating rates %e might use the @5P method ofdepreciation. $his method usually used to calculatedepletion of mines oil wells and standingtim7er. $hus cost depletion is computed li#e U
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*ost Depletion
Eample 11-12! small lumber company bought a tract of timberfor ;3*444 of %hich ;*444 %as the land/s valueand ;34444 %as the value of the estimated 1
million board-feet of standing timber. $he 9rst yearthe company cut 144444 board-feet of standingtimber. hat %as the year/s depletion allo%ance
$he depletion allo%ance for the year %ould be:
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$ercentage Depletion
=ercentage depletion is an alternate method formineral property and some oil or gas wells.Unli#e depreciation the percentage depletionallo%ance is 7ased on the property/s grossincome. (ince percentage depletion is computedon the income rather than the property/s cost thetotal depletion may ecee% the cost of the !ro!erty . &n computing the allowable percentagedepletion on a property in any year the percentage
depletion allowance cannot e!ceed (' of theproperty/s ta!a7le income computed %ithout thedepletion deduction.
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$ercentage Depletion
=ercentage of depletion depends on the type ofdeposit as follo%s:
Eample 11-13! coal mine has a gross income of ;2*4444 for theyear. Bining epenses e+ual ;214444. Computethe allo%able percentage depletion deduction.
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$ercentage Depletion
omputed percentage depletionMross income from mine ; 2*4444
Depletion percentage 14J
omputed percentage depletion ; 2*444
Ta!a7le income limitationMross income from mine ; 2*4444
Ness: Epenses other than depletion - 214444
Ta!a7le income from mine )4444
Deduction limitation *4J
Ta!a7le income limitation ; 24444(ince the taable income limitation ,; 24444 Ocomputed percentage depletion ,;2*444 the allo%ablepercentage depletion deduction is ;24444.
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END OF CLASSAny Further Questions?