Depreciation
Construction Engineering 221
Economic Analysis
Depreciation
• Depreciation is an artificial (non-cash)
accounting entry intended to capture the
consumption of a capital asset over its
economic life
• Depreciation increases after tax profit, so
firms desire to depreciate assets as fast as
possible (depreciation schedule has major
tax implications)
Depreciation
• Depreciation basis is that part of the
asset’s purchase price that is spread over
the depreciation period (service life).
• Depreciation basis is cost minus expected
salvage value at the end of the service
period
• IRS regulations spell out the types of
depreciation schedules and bases for
most business assets.
Depreciation
• Depreciation methods
– Straight line D = C-S/n
– Constant percentage (same as straight line
except a percentage is used- may be better
for hours on an turbine, for example)
– Double declining balance
• D1 = 2C/n, Dj = 2(C-sum Dm, 1,j-1)/n
– Sum-of the-years’ digits (SOYD)
• T=1/2*n*(n+1); Dj = (c-s)(n-j+1)/T
Depreciation
• Statutory depreciation
– Accelerated cost recovery schedules (ACRS)
and modified accelerated recovery schedules
(MACSR) governs all depreciation on
business assets put in service after 1980.
– Look up the depreciation factors in the tax
code and multiply: Dj + C X factor for the
service life of the asset
Depreciation
• Other methods
– Production output (similar to percentage)
– Sinking fund method- like a reverse
mortgage- initial depreciation is low. Almost
never used.
– “plus interest” methods- never used.
Accounts for the time-value of the money
being depreciated.