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Chapter 17
Depreciation
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McGraw-Hill/Irwin
Copyright © 2003 by The McGraw-Hill Companies, Inc. All rights reserved.
#17
Depreciation
Learning Unit Objectives
LU17.1 Concepts of Depreciation and the Straight-
Line Method
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•
Explain the concept and causes of depreciation
•
Prepare a depreciation schedule and calculate
partial-year depreciation
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Depreciation
Learning Unit Objectives
LU17.2 Units-of-Production Method
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•
Explain how use affects the units-of-production
method
•
Prepare a depreciation schedule
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Depreciation
Learning Unit Objectives
LU17.3 Sum-of-the-Years’-Digits Method
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•
Explain how to use the fraction in the sum-ofthe-years’-digits method
•
Prepare a depreciation schedule
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Depreciation
Learning Unit Objectives
LU17.4 Declining-Balance Method
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•
Explain the importance of residual value in the
depreciation schedule
•
Prepare a depreciation schedule
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Depreciation
Learning Unit Objectives
LU17.5 Modified Accelerated Cost Recovery
System (MACRS) with Introduction
to ACRS
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•
Explain the goals of ACRS and MACRS and
their limitations
•
Calculate depreciation using the MACRS
guidelines
Concept of Depreciation
Depreciation - An estimate of
the use or deterioration of an
asset
Asset Cost - Amount paid
for an asset including
freight charges
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Accumulated Depreciation The total amount of the asset’s
depreciation taken to date
Estimated Useful Life Number of years or time
periods for which the
company can be use the asset
Concept of Depreciation
Residual Value (Salvage
Value) - Expected cash
value at the end of an
assets useful life.
Book Value - The unused amount of the
asset cost that may be depreciated in
future accounting periods
Book Value = Asset cost - Accumulated
Book value
Book value cannot be less than residual value
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Causes of Depreciation
Product Obsolescence
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Physical Deterioration
Straight-Line Method
Distributes the same amount of expense to each period of time
Depreciation expense =
Cost - Residual value
each year
Estimated useful life in years
Sam’s delivery company buys a new truck to make deliveries. The
truck cost $20,000, the estimated useful life is 5 years. After 5 years
the residual value is $1,000. Calculate depreciation expense and
complete a depreciation schedule.
$20,000 - $1,000 = $3,800
5
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100% = 100% = 20%
# of yrs.
5
Depreciation Schedule
End of
year
Cost of
equipment
Depreciation
expense for
year
Accumulated
depreciation
at end of year
Book value at end
of year (Cost Accumulated
depreciation)
1
2
3
$20,000
$20,000
$20,000
$3,800
$3,800
$3,800
$ 3,800
$ 7,600
$11,400
$16,200
$12,400
$ 8,600
4
5
$20,000
$20,000
$3,800
$3,800
$15,200
$19,000
$ 4,800
$ 1,000
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Depreciation for Partial Years
Assume Sam’s Delivery bought the truck August 10th.
What would be depreciation for t he first year?
Depreciation expense =
Cost - Residual value
each year
Estimated useful life in years
$20,000 - $1,000 = $3,800 x 5 = $1583.33
5
12
Aug, Sept., Oct.,
Nov., & Dec.
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Units-of-Production Method
Depreciation determined by how much the company uses the asset
Depreciation expense =
Cost - Residual value
per unit
Total estimated units produced
Depreciation = Unit
x
amount
depreciation
Units
produced
Sam’s delivery company buys a new truck to make deliveries. The
truck cost $20,000, the estimated useful life is 100,000 miles. After 5
years the residual value is $1,000. Calculate depreciation expense and
complete a depreciation schedule.
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Depreciation Schedule
End of
year
Cost of
equipment
Units
prod.
Depreciation
expense for
year
Accumulated
depreciation
at end of year
Book value
at end
of year
1
2
3
$20,000
$20,000
$20,000
20,000
15,000
25,000
$3,800
$2,850
$4,750
$ 3,800
$ 6,650
$11,400
$16,200
$13,350
$ 8,600
4
5
$20,000
$20,000
22,000
18,000
$4,180
$3,420
$15,580
$19,000
$ 4,420
$ 1,000
$20,000 - $1,000 = $.19 per unit
100,000
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15,000 x $.19
Sum-of-the-Years’ Digits Method
Accelerated depreciation method which computes more
depreciation expense in the early years of the asset’s life
Depreciation = (Cost - Residual value) x
Remaining life
expense
Sum-of-the-Years’ Digits
Sum of the asset’s service life
5+4+3+2+1=15 or N(N+1) = 5(5+1) = 30 = 15
2
2
2
Sam’s delivery company buys a new truck to make deliveries. The
truck cost $20,000, the estimated useful life is 5 years. After 5 years
the residual value is $1,000. Calculate depreciation expense and
complete a depreciation schedule.
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Depreciation Schedule
End of Cost year
Res. Value
Depreciation
Fraction expense for
for year
year
Accumulated
depreciation
at end of year
Book value
at end
of year
1
2
3
$19,000
$19,000
$19,000
5/15
4/15
3/15
$6,333.33
$5,066.67
$3,800
$6,333.33
$11,400
$15,200
$13,666.67
$8,600
$4,800
4
5
$19,000
$19,000
2/15
1/15
$2,533.33
$1,266.67
$17,733.33
$19,000
$2,266.67
$1,000
$20,000 - $1,000
= $19,000
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$19,000 x 4
15
Declining-Balance Method
Accelerated method which computes more depreciation expense
in the early years of the asset’s life. Uses up to twice the straightline rate
Rate = 100% x 2 = 40%
5 years
Depreciation expense = Book value of equip. x Depreciation
each year
at beginning of year
rate
Sam’s delivery company buys a new truck to make deliveries. The
truck cost $20,000, the estimated useful life is 5 years. After 5 years
the residual value is $1,000. Calculate depreciation expense and
complete a depreciation schedule.
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Depreciation Schedule
Rate = 100% x 2 = 40%
5 years
Accumulated Book value at Depreciation Accumulated
End of Cost of depreciation
beginning
expense for depreciation
year
Truck at beg. of year of year
year
at end of year
1
2
3
4
5
$20,000
$20,000
$20,000
$20,000
$20,000
0
$ 8,000
$12,800
$15,680
$17,408
$20,000
$12,000
$ 7,200
$ 4,320
$ 2,592
$8,000
$4,800
$2,880
$1,728
$1,036.80
$ 8,000
$12,800
$15,680
$17,408
$18,444.80
Book value
at end
of year
$12,000
$7,200
$4,320
$2,592
$1,555.20*
$12,000 x .40
*Since we do not reach the residual value of $1,000 another $555.20 could have been taken as
depreciation expense to bring it to the estimated residual value of $1,000
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Modified Accelerated Cost Recovery System
(MACRS) with Introduction to (ACRS)
Federal tax laws state how
depreciation must be taken for
income tax purposes
Provides users with tables giving
the useful lives of various assets and
the depreciation rates
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Table 17.5 - Modified Accelerated Cost
Recovery System (MACRS)
Class recovery
Period (life)
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Asset types
3-year
Racehorses more than 2 years old or any horse other than a
racehorse that is more than 12 years old at the time
place into service special tools of certain industries.
5-year
Automobiles (not luxury) taxis; light general purpose trucks;
semiconductor manufacturing equipment computer-based telephone
central-office switching equipment qualified technological equipment;
property used in connection with research and experimentation.
7-year
Railroad track single-purpose agricultural (pigpens), or horticultural;
structures; fixtures; equipment; furniture.
10-year
New law doesn’t add any specific property under this class.
15-year
Municipal wastewater treatment plants; telephone distribution plants and
comparable equipment used for two-way exchange of voice and data
communications.
20-year
Municipal sewers.
27.5-year
Only residential property.
31.5-year
Only nonresidential real property.
Key points of MACRS
1. It calculates depreciation for tax purposes.
2. It ignores residual value.
3. Depreciation if the first year (for personal property) is based on the
assumption that the asset was purchased halfway through the year. (A new
law adds a midquarter convention for all personal property if more than 40%
is placed in service during the last 3 months of the taxable year.)
4. Classes 3,5,7, and 10 use a 200% declining-balance method for a period of
years before switching to straight-line depreciation. You do not have to
determine the year in which to switch since Table 17.6 builds this into the
calculation.
5. Classes 15 and 20 use a 150% declining-balance method before switching to
straight-line depreciation.
6. Classes 27.5 and 31.5 use straight-line depreciation.
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Table 17.6 - Annual Recovery for MACRS
Recovery 3-year class
year
(200% D.B.)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
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33.00
45.00
15.00
7.00
5-year class
(200% D.B.)
7-year class
(200% D.B.)
10-year class
(200% D.B.)
15-year class
(150% D.B.)
20-year class
(150% D.B.)
20.00
32.00
19.20
11.52
11.52
5.76
14.28
24.49
17.49
12.49
8.93
8.93
8.93
4.46
10.00
18.00
14.40
11.52
9.22
7.37
6.55
6.55
6.55
6.55
3.29
5.00
9.50
8.55
7.69
6.93
6.23
5.90
5.90
5.90
5.90
5.90
5.90
5.90
5.90
5.90
3.00
3.75
7.22
6.68
6.18
5.71
5.28
4.89
4.52
4.46
4.46
4.46
4.46
4.46
4.46
4.46
4.46
Depreciation Schedule
End of
year
Cost of
equipment
Depreciation
expense for
year
Accumulated
depreciation
at end of year
Book value
at end
of year
1
$20,000
$4,000
($20,000 x .20)
$4,000
$16,000
2
$20,000
$10,400
$9,600
3
4
$20,000
$20,000
$6,400
($20,000 x .32)
$3,840
$2,304
$14,240
$16,544
$5,760
$3,456
5
6
$20,000
$20,000
$2,304
$1,152
$18,848
$20,000
$1,152
$0
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