DEPRECIATION
McGraw-Hill/Irwin
Chapter
Seventeen
Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved.
LEARNING UNIT OBJECTIVES
LU 17-1: Concepts of Depreciation and the Straight-Line Method
1.
Explain the concept and causes of depreciation.
2.
Prepare a depreciation schedule and calculate partial-year depreciation.
LU 17-2: Units-of-Production Method
1.
Explain how use affects the units-of-production method.
Prepare a depreciation schedule.
LU 17-3: Declining-Balance Method
2.
1.
Explain the importance of residual value in the depreciation schedule.
2.
Prepare a depreciation schedule.
LU 17-4: Modified Accelerated Cost Recovery System (MACRS) with
Introduction to ACRS
1.
Explain the goals of ACRS and MACRS and their limitations.
2.
Calculate depreciation using the MACRS guidelines.
17-2
ACCOUNTING EQUATION AND
BALANCE SHEET
Accounting Equation: Assets = Liabilities + Owner’s Equity
Balance Sheet: Gives a financial picture of what a company is worth as of
particular date.
=
Assets
(How much the
company owns)
Liabilities + Owner’s Equity
(How much
the owner
is worth)
(How much
the company
owes)
17-3
CONCEPT OF DEPRECIATION
Asset Cost –
Depreciation –
Amount paid for an asset including
freight charges
An estimate of the use or
deterioration of an asset
Estimated Useful Life –
Accumulated Depreciation –
Number of years or time periods
for which the company can use
the asset
The total amount of the asset’s
depreciation taken to date
17-4
CONCEPT OF DEPRECIATION
Book Value - The unused amount of the asset cost that may be depreciated in future
accounting periods.
Book value = Asset cost -- Accumulated book value
Residual Value (Salvage Value) - Expected cash value at the end of an asset’s useful life.
Book value cannot be less than residual value.
17-5
CAUSES OF DEPRECIATION
Product Obsolescence
Physical Deterioration
17-6
STRAIGHT-LINE METHOD
Distributes the same amount of expense to each period of time.
Depreciation expense
each year
=
Cost -- Residual value
Estimated useful life in years
Example:
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
5
= $400
100% = 100% = 20%
# of yrs.
5
17-7
DEPRECIATION SCHEDULE
17-8
DEPRECIATION FOR PARTIAL YEARS
Assume Ajax Company bought equipment for $2,500. The
estimated useful life is five years. The residual value is $500.
What would be depreciation for the first year?
Depreciation expense each year =
15th
Rule
Cost -- Residual value
Estimated useful life in years
$2,500 -- $500 = $400 x 8 = $266.67
12
5
May, June, July,
Aug, Sept., Oct.,
Nov., & Dec.
17-9
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 =
amount
Unit
x
depreciation
Units
produced
Example:
Ajax Company (in Learning Unit 17–1) buys equipment, and 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.
17-10
DEPRECIATION SCHEDULE
17-11
DECLINING-BALANCE METHOD
Accelerated method which computes more depreciation expense in the early
years of the asset’s life. Uses up to twice the straight-line rate.
Rate = 100% x 2 = 40%
5 years
Depreciation expense =
each year
Book value of equipment x Depreciation
at beginning of year
rate
Example:
Ajax Company (in Learning Unit 17–1) buys equipment, and 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.
17-12
DEPRECIATION SCHEDULE
17-13
MODIFIED ACCELERATED COST
RECOVERY SYSTEM (MACRS)
• 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.
17-14
KEY POINTS OF MACRS
1. It calculates depreciation for tax purposes.
2. It ignores residual value.
3. Depreciation in 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.
17-15
MODIFIED ACCELERATED COST RECOVERY
SYSTEM (MACRS) (TABLE 17.4)
17-16
ANNUAL RECOVERY FOR MACRS
(TABLE 17.5)
Recovery 3-year class
year
(200% D.B.)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
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
17-17
DEPRECIATION SCHEDULE
17-18