Chapter 17 – Depreciation. In this chapter, the learning objectives are: Concepts of depreciation and the straight-line method, units-of-production method, declining-balance method, modified accelerated cost recovery system (MACRS) with introduction to ACRS.
Chapter 17 Depreciation McGrawHill/Irwin ©2011 The McGrawHill Companies, All Rights Reserved #17 Depreciation Learning Unit Objectives Concepts of Depreciation and the LU17.1 StraightLine Method Explain the concept and causes of depreciation Prepare a depreciation schedule and calculate partialyear depreciation 172 #17 Depreciation Learning Unit Objectives LU17.2 UnitsofProduction Method Explain how use affects the unitsof production method Prepare a depreciation schedule 173 #17 Depreciation Learning Unit Objectives LU17.3 DecliningBalance Method Explain the importance of residual value in the depreciation schedule Prepare a depreciation schedule 174 #17 Depreciation Learning Unit Objectives LU17.4 Modified Accelerated Cost Recovery System (MACRS) with Introduction to ACRS Explain the goals of ACRS and MACRS and their limitations Calculate depreciation using the MACRS guidelines 175 Concept of Depreciation Depreciation An estimate of the use or deterioration of an asset Asset Cost Amount paid for an asset including freight charges 176 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 177 Causes of Depreciation Product Obsolescence 178 Physical Deterioration StraightLine Method Distributes the same amount of expense to each period of time Depreciation expense = Cost Residual value each year Estimated useful life in years Ajax Company buys equipment, the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule $2,500 $500 = $400 5 179 100% = 100% = 20% # of yrs. 5 Depreciation Schedule Accumulated depreciation at end of year $2,500 $400 $ 400 $2,100 $2,500 $400 $ 800 $1,700 $2,500 $400 $1,200 $1,300 $2,500 $400 $1,600 $ 900 $2,500 $400 $2,000 $ 500 E Re qua sid ls Va ua lue l End of Cost of year equipment Depreciation expense for year Book value at end of year (Cost Accumulated depreciation) 1710 Depreciation for Partial Years 15th Rule Assume Ajax Company bought equipment for $2,500. What would be depreciation for the first year? The estimated useful life is five years Depreciation expense = Cost Residual value each year Estimated useful life in years $2,500 $500 = $400 x 8 = $266.67 12 May, June, July, Aug, Sept., Oct., Nov., & Dec 1711 UnitsofProduction 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 Units amount depreciation produced Ajax Company (in Learning Unit 17–1) buys equipment, the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule 1712 Depreciation Schedule End of Cost of year equipment Depreciation Units expense for prod. year Accumulated Book value depreciation at end at end of year of year $2,500 300 $150 $ 150 $2,350 $2,500 400 $200 $ 350 $2,150 $2,500 600 $300 $ 650 $1,850 $2,500 2,000 $1,000 $1,650 $ 850 $2,500 $350 $2,000 $ 500 700 $2,500 $500 = $.50 per unit 4,000 1713 400 x $.50 DecliningBalance 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 Ajax Company (in Learning Unit 17–1) buys equipment, the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule 1714 Depreciation Schedule Rate = 100% x 2 = 40% 5 years Accumulated Book value at Depreciation End of Cost of depreciation beginning expense for year Truck at beg. of year of year year Accumulated depreciation at end of year 1 $2,500 0 $1,000 $1,500 2 $2,500 $1,000 $1,500 $ 600 $1,600 $ 900 3 $2,500 $1,600 $ 900 $ 360 $1,960 $ 540 4 $2,500 $1,960 $ 540 $ 40 $2,000 $ 500 5 $2,500 $2,000 $ 500 $ 0 $2,000 $ 500 $2,500 $1,000 $1,500 x .40 1715 Book value at end of year 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 1716 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% decliningbalance method for a period of years before switching to straightline 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% decliningbalance method before switching to straightline depreciation 6. Classes 27.5 and 31.5 use straightline depreciation 1717 Table 17.4 Modified Accelerated Cost Recovery System (MACRS) Class recovery Period (life) 1718 Asset types 3year 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 5year Automobiles (not luxury) taxis; light general purpose trucks; semiconductor manufacturing equipment computerbased telephone centraloffice switching equipment qualified technological equipment; property used in connection with research and experimentation 7year Railroad track singlepurpose agricultural (pigpens), or horticultural; structures; fixtures; equipment; furniture 10year New law doesn’t add any specific property under this class 15year Municipal wastewater treatment plants; telephone distribution plants and comparable equipment used for twoway exchange of voice and data communications 20year Municipal sewers 27.5year Only residential property 31.5year Only nonresidential real property Table 17.5 Annual Recovery for MACRS Recovery 3-year class year (200% D.B.) 10 11 12 13 14 15 16 1719 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 Cost of year equipment Depreciation expense for year Accumulated depreciation at end of year Book value at end of year $500 $500 $2,000 $1300 $1,200 $2,500 ($2,500 x .20) $2,500 $800 ($2,500 x .32) 1720 $2,500 $480 $1,780 $ 720 $2,500 $288 $2,068 $ 432 $2,500 $288 $2,356 $ 144 $2,500 $144 $2,500 $ 0 ... Only nonresidential real property Table 17. 5 Annual Recovery for MACRS Recovery 3-year class year (200% D.B.) 10 11 12 13 14 15 16 17 19 33.00 45.00 15.00 7.00 5-year class (200% D.B.) 7-year class (200% D.B.) 10-year class... calculate partialyear depreciation 17 2 #17 Depreciation Learning Unit Objectives LU17.2 UnitsofProduction Method Explain how use affects the unitsof production method Prepare a depreciation schedule 17 3 #17 Depreciation... 6. Classes 27.5 and 31.5 use straightline depreciation 17 17 Table 17. 4 Modified Accelerated Cost Recovery System (MACRS) Class recovery Period (life) 17 18 Asset types 3year Racehorses more than 2 years old or any horse other than a