Chapter 17
Depreciation
McGraw-Hill/Irwin
Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.
#17
Depreciation
Learning Unit Objectives
Concepts of Depreciation and the
LU17.1
Straight-Line Method
1. Explain the concept and causes of
depreciation
2. Prepare a depreciation schedule and
calculate partial-year depreciation
17-2
#17
Depreciation
Learning Unit Objectives
LU17.2 Units-of-Production Method
1. Explain how use affects the units-of-
production method
2. Prepare a depreciation schedule
17-3
#17
Depreciation
Learning Unit Objectives
LU17.3 Declining-Balance Method
1. Explain the importance of residual
value in the depreciation schedule
2. Prepare a depreciation schedule
17-4
#17
Depreciation
Learning Unit Objectives
LU17.4 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
17-5
Concept of Depreciation
Depreciation - An estimate of
the use or deterioration of an
asset
Asset Cost - Amount paid
for an asset including
freight charges
17-6
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
17-7
Causes of Depreciation
Product Obsolescence
17-8
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
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
17-9
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
$2,500
$2,500
$400
$400
$ 400
$ 800
$2,100
$1,700
3
4
5
$2,500
$2,500
$2,500
$400
$400
$400
$1,200
$1,600
$2,000
$1,300
$ 900
$ 500
17-10
Depreciation for Partial Years
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
5
12
May, June, July,
Aug, Sept., Oct.,
Nov., & Dec.
17-11
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
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.
17-12
Depreciation Schedule
End of
year
Cost of
equipment
Units
prod.
1
2
$2,500
$2,500
300
400
3
4
5
$2,500
$2,500
$2,500
600
2,000
700
Depreciation
expense for
year
Accumulated
depreciation
at end of year
Book value
at end
of year
$150
$200
$ 150
$ 350
$2,350
$2,150
$300
$1,000
$350
$ 650
$1,650
$2,000
$1,850
$ 850
$ 500
$2,500 - $500 = $.50 per unit
4,000
17-13
400 x $.50
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 = 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.
17-14
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
Book value
at end
of year
1
2
3
4
5
$1,500
$ 900
$ 540
$ 500
$ 500
$2,500
$2,500
$2,500
$2,500
$2,500
0
$2,500
$1,000 $1,500
$1,600 $ 900
$1,960 $ 540
$2,000 $ 500
$1,500 x .40
17-15
$1,000
$ 600
$ 360
$ 40
$
0
$1,000
$1,600
$1,960
$2,000
$2,000
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
17-16
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.
17-17
Table 17.4 - Modified Accelerated
Cost Recovery System (MACRS)
Class recovery
Period (life)
17-18
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.
Table 17.5 - 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
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
(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
17-20
Cost of
equipment
Depreciation
expense for
year
1
$2,500
2
$2,500
$500
($2,500 x .20)
$800
3
4
5
$2,500
$2,500
$2,500
($2,500 x .32)
$480
$288
$288
6
$2,500
$144
Accumulated
depreciation
at end of year
Book value
at end
of year
$500
$2,000
$1300
$1,200
$1,780
$2,068
$2,356
$ 720
$ 432
$ 144
$2,500
$
0
Problem 17-19:
Year 1
17-21
$22,220 X 0.20 = $4,444
$22,220 - $4,444 = $17,776
Problem 17-21:
a. $36,000 - $6,000 $30,000
5 years
= 5 years = $6,000
depreciation expense
b. $36,000 $18,000 = $18,000
Cost
- accumulated depreciation
17-22
Problem 17-23:
19,000 miles x $.86 =
$16,340 accumulated depreciation
Cost
$70,000 -
Accumulated Depreciation
$16,340
$53,660 book value
-$46,900 paid
$ 6,760 below book value
17-23
Book Value
= $53,660
Problem 17-25:
$108,000 - $35,000 = $24,333.333 = $24,333
3
depreciation
each year
$108,000 - $24,333 = $83,667 book value after first yr
17-24