16-1 lecture slides to accompany engineering economy 7 th edition leland blank anthony tarquin...
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16-1
Lecture slides to accompany
Engineering Economy7th edition
Leland Blank
Anthony Tarquin
Chapter 16Depreciation
Methods
© 2012 by McGraw-Hill All Rights Reserved
16-2
LEARNING OUTCOMES
1. Understand basic terms of asset depreciation
2. Apply straight line method of depreciation
3. Apply DB and DDB methods of depreciation
4. Apply MACRS method of depreciation
5. Select asset recovery period for MACRS
6. Explain depletion and apply cost depletion & percentage depletion methods
© 2012 by McGraw-Hill All Rights Reserved
© 2012 by McGraw-Hill All Rights Reserved16-3
Depreciation Terminology
Definition: Book method to represent decrease in value of an asset w/time
Two types: book depreciation & tax depreciation
Book depreciation: used for internal accounting to track value of assets
Tax depreciation: used to determine taxes due based on tax laws
In U.S., tax depreciation must be calculated using MACRS;book depreciation can be calculated using any method
16-4
Common Depreciation Terms
© 2012 by McGraw-Hill All Rights Reserved
First cost P or unadjusted basis: total installed cost of asset
Book value: remaining undepreciated capital investment
Recovery period: depreciable life of asset in years
Market value: amount realizable if asset were sold in open market
Salvage value: trade-in or market value at end of asset’s useful life
Depreciation rate: fraction of first cost removed by depreciation each year
Personal property: possessions of company used to conduct business
Real property: real estate & all improvements (land not depreciable)
Half-year convention: assumes assets are placed in service in midyear
16-5
Straight Line Depreciation
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Book value decreases linearly with time
Dt = B - Sn
Where: D = annual depreciation charge t = year B = first cost or unadjusted basis S = salvage value n = recovery period
BVt = B - tDt Where: BVt = book value after t years
16-6
Example SL Depreciation
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Solution: (a ) D3 = (P – S)/n = (20,000 – 5000)/5 = $3000
(b) BV3 = B – tDt
= 20,000 – 3(3000) = $11,000
A certain machine has a first cost of $20,000 with a $5,000salvage value after 5 years. Find D and BV for year three.
16-7
Declining Balance Depreciation
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Determined by multiplying BV at beginning of year by fixed percentage, d
Max rate for d is twice straight line rate = 2/nCannot depreciate below book value
Depreciation for year t is given by: Dt = dB(1 – d)t-1 where: Dt = depreciation for year t t = depreciation year d = uniform depreciation rate (2/n for DDB)
B = first cost or unadjusted basis
Book value for year t is given by: BVt = B(1 – d)t
16-8
Example Declining Balance
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(b) BV3 = B(1 – d)t
= 20,000(1 – 0.4)3 = $4320
A certain machine has a first cost of $20,000 with a $4,000salvage value after 5 years. Find (a) the depreciation, and(b) the book value after 3 years using DDB depreciation.
Solution: (a) d = 2/n = 2/5 = 0.4 D3 = dB(1 – d)t-1 = 0.4(20,000)(1 – 0.40)3-1 = $2800
16-9
MACRS Depreciation
© 2012 by McGraw-Hill All Rights Reserved
Required method to use in U.S. for tax depreciation
Can depreciate to below salvage value
Dt = dtB Where: Dt = depreciation charge for year t t = year B = first cost or unadjusted basis
BVt = B - ∑Dj Where: BVt = book value after t years Dj = depreciation in year jJ=1
J=t
Get value for dt from table
16-10
Example: MACRS Depreciation
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Solution:
A certain machine has a first cost of $20,000 with a $5,000salvage value after 5 years. Find (a) D and (b) BV for year 3
(a) From table, d3 = 19.20 D3= 20,000(0.1920) = $3,840
(b) BV3 = 20,000 - 20,000(0.20 + 0.32 + 0.192) = $5,760
© 2012 by McGraw-Hill All Rights Reserved16-11
MACRS Recovery PeriodRecovery period (i.e. n) is function of property class
Two systems for determining recovery period:
general depreciation system (GDS)
alternative depreciation system(ADS)
IRS publication 946 gives n values for each system. For example: n valueAsset description GDS ADS rangeSpecial manufacturing devices, racehorses, tractors 3 3 - 5 Computers, oil drilling equipment, autos, trucks, buses 5 6 - 9.5Office furniture, railroad car, all property not in other class 7 10 – 15 Nonresidential real property (not land itself) 39 40
16-12 © 2012 by McGraw-Hill All Rights Reserved
Depletion Methods
Depletion represents decreasing value of natural resources
Two methods: cost depletion and percentage depletion
Cost depletion: Multiply factor by amount of resource removed where factor, CDt = first cost / resource capacity
Percentage depletion: Multiply gross income by PD % from Table
© 2012 by McGraw-Hill All Rights Reserved16-13
Example: Depletion A silver mine purchased for $3.5 million is expected to yield one million ounces of silver. Determine the depletion charge in a year when 300,000 ounces are mined and sold for $30 per ounce by (a) Cost depletion, and (b) Percentage depletion.
Solution:(a) Cdt = 3,500,000/ 1,000,000 = $3.50 per ounce Cost depletion = 3.50(300,000) = $1,050,000(b) Percentage depletion = 300,000(30)(0.15) = $1,350,000
16-14
Summary of Important Points
© 2012 by McGraw-Hill All Rights Reserved
Two methods of depletion: cost (amount resource removed* CDt factor) & percentage (income*PD % from table)
Two methods for depreciation: tax and book
In U.S., MACRS method is used for tax depreciation
Two systems for determining recovery period: GDS & ADS
Depletion (instead of depreciation) used for natural resources
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