Depreciation

Chapter 4

Depreciation

Allocating the expense of a resource which lasts > 1 year.

e.g. tractors, barns, bulls, fences. Calculation

Need to know: 1. Purchase Price – Cost 2. Useful Life – Life 3. Salvage Value – S.V. 4. Depreciation Method – Meth

Depreciation Methods: Straight Line

Annual Depreciation = (cost-salvage value) /useful lifeOr

Annual Depreciation = (cost–salvage value)*R

Where R is the annual straight- line percentage rate found by dividing 100% by the useful life (100% / useful life)

Depreciation Methods: Sum of the Year’s Digits (SOYD)

Annual Depreciation = (cost-salvage value) * RL/ SOYD Where RL= remaining years of useful life as of the beginning

of the year for which depreciation is being computed. SOYD= sum of all the number from 1 through the

estimated useful life. For example for a 5-year useful life, SOYD would be 1+2+3+4+5=15 and it would be 55 for a 10 year useful life.

Highest the first year and then declines by a constant amount after.

Depreciation Method: Declining Balance Annual Depreciation is = (Book Value at

Beginning of Year) * RWhere R is a constant percentage value or rate.

A variation on this is double declining balance.

Can’t have a zero salvage value.

Depreciation Method: Partial Year Depreciation For an asset purchase during the year the

depreciation should be prorated for the amount of time that asset was used during the year.

Income Tax Depreciation

Current system is called MACRS Assumptions:

1. An implied salvage value of zero

2. One-half year of depreciation allowed in the year of purchase regardless of the purchase date (some exceptions)

3. A system of property classes which fixes the useful life for each type of property.

3-,5-,7-,10-,15-, or 20- year classesExamples

3-year: breeding hogs 5-year: cars, pickups, breeding cattle and sheep, dairy

cattle, computers, trucks. 7-year: most farm machinery and equipment, fences,

grain bins, silos, office furniture 10-year: Single purpose agricultural and horticulture

structures such as confinement swine facilities and green houses as well as trees bearing fruits or nuts.

15-year: water wells, paved lots, drainage tile. 20-year: general-purpose buildings such as machine

sheds and hay barns

Income Tax Depreciation

Rates are now based on the 150% declining balance method.

An example for a 5-year class of property15%

25.5%

17.85%

16.66%

16.66%

8.33% Notice it’s 6 years. Get only a half year the first year

and a half the last.

Income Tax Depreciation

Valuation of Assets

It is necessary to determine the value of assets Tax-purpose Profit/ Income purposes

1. Market Value

Current market price “Fair Market Value” Could or will be sold in short period of time Ex: Stocks, bonds, cattle, hay, grain

2. Cost

Valued at their original cost This method works well for items that have to

be purchased frequently. eg. Supplies, feed, fertilizer

Items that lose value over time should not be valued with this method

3. Lower of Cost or Market

Value it at both and take the lower. Minimizes change of placing too high a value

on any item.

Truck Price increases > $12,000 (inflation)

Cost $12,000

Anything lower is market value.

4. Farm Production Cost

Items produced on farm can be valued at their production costs. ie. Corn used for feeding.

No opportunity costs

*Conservative Valuation.

5. Cost Less Depreciation

Original cost less depreciation

Machinery, buildings, fences, breeding livestock

Resulting value commonly termed book value.