Introductory Mathematics
& Statistics
Chapter 8
Depreciation
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8-1
Learning Objectives
•
Use the latest depreciation rules of the Australian Taxation
Office
•
Calculate depreciation using the prime cost (straight line)
method
•
Calculate depreciation using the diminishing value (reducing
balance) method
•
Calculate depreciation rates using the units-of-production
method
•
Prepare a depreciation schedule
•
Calculate the current written-down value (book value) of an
asset
•
Keep depreciation records
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8-2
8.1 Introduction
• Depreciable assets
– The value of an asset gradually reduces over time as it
approaches the end of its useful life. Assets that lose value
in this way are said to depreciate
– The amount of this lost value is called depreciation and
represents a depreciation expense
– The assets themselves are known as depreciable assets,
and each one has limited effective life
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8.1 Introduction (cont…)
• Possible causes of depreciation include
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physical deterioration
obsolescence
inadequacy
lack of utility
exhaustion
the passage of time
• The cost of an item for depreciation purposes includes:
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the original purchase price or construction cost
transport costs
installation costs
customs duty
relocation costs
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8.1 Introduction (cont…)
• The depreciation provisions apply to plant, which means
articles or assets that are used to produce assessable
income, or are installed ready for use to produce income and
are held in reserve.
• Examples include:
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computers
electrical tools
furniture and fittings
furnishings
manufacturing machinery
motor vehicles
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8.1 Introduction (cont…)
• Simplified depreciation rules
– If you choose to use the simplified depreciation rules, you
must use them to work out deductions for all your
depreciating assets that the rules apply to
– You can pool into a general small business pool and deduct
at the rate of 30% most other depreciating assets with
effective lives of less than 25 years
– If the depreciating assets have effective lives of 25 years or
more they can be pooled into a long-life small business pool
and deducted at the rate of 5%
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8.2 The simplified tax system
• The simplified (depreciation) rules under the simplified tax
system (STS) provide small businesses with significant
concessions
• These rules involve simpler calculations and remove the
need to calculate depreciation separately for each asset
• Under the simplified depreciation rules, you can claim an
immediate deduction for most depreciating assets costing
less than $1000 and pool most other depreciating assets
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8.2 The simplified tax system (cont…)
• Small business pools
– You may combine assets into small business pools as
follows:
• the general small business pool—for assets with
effective lives of less than 25 years
• the long-life small business pool—for assets with
effective lives of 25 years or more
– If you held any assets at the start of the income year that
you chose to use these rules, you must generally allocate
them to a pool at the beginning of that year
– The opening pool balance is the taxable-purpose proportion
of the adjustable values of all depreciating assets in your
pool
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8-8
8.2 The simplified tax system (cont…)
• Using the simplified depreciation rules for the first
time
– When you first use the simplified depreciation rules, you
must work out each pool’s opening balance
– In later years, you must review, and in some cases
adjust, the opening pool balance for the changes to
taxable purpose proportion before working out your pool
deduction
Copyright  2010 McGraw-Hill Australia Pty Ltd
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8.2 The simplified tax system (cont…)
• Continuing to use the simplified depreciation rules
– In later years, you may need to adjust the opening pool
balance before calculating your pool deduction if you:
 change the extent to which you use a pooled asset for a
taxable purpose, or
 have assets that you started to use, or hold ready to use,
since last choosing to use these rules
– The adjustment will ensure that your pool deduction is
based on the correct estimate of the adjustable value of
all your assets and their taxable-purpose proportions for
the current and future income years
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8.2 The simplified tax system (cont…)
• Adjustable value
– You must work out the adjustable value of each
depreciating asset you start to use, or have installed
ready to use, for a taxable purpose
– The adjustable value of an asset is its cost less its decline
in value since you first used it
– The asset’s cost does not include any amount that you
can claim as a GST credit
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8.2 The simplified tax system (cont…)
• Low-cost assets
– A low-cost asset is one whose cost at the end of the year
you first used it for a taxable purpose is less than $1000
(Note: This definition excludes horticultural plants)
– You use an asset for a taxable purpose if you use it to
produce assessable income
– You can claim an immediate deduction for low-cost
assets in the income year that you first use those assets,
for a taxable purpose
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8.3 Methods of depreciation
• You can work out the decline in value of a depreciating
asset using either the prime-cost method (also known as the
straight-line method) or the diminishing-value method (also
known as the reducing-balance method)
• Once a particular method of depreciation for an item is
adopted, you may not change to the other method for that
item
• For most depreciating assets, you can choose whether to
self-assess the effective life or adopt the taxation
Commissioner’s determination
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8.3 Methods of depreciation (cont…)
• Non-business use
– A deduction for the decline in value of a depreciating asset
is not allowable if the depreciating asset is used solely for
private purposes
• Assets held at the start of the year
– How you apply the simplified depreciation rules to
depreciate assets that you held at the start of the year
depends on whether this is the first year you are using the
rules or whether you have used them in a previous year
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8.3 Methods of depreciation (cont…)
• Depreciating assets held before 1 July 2001
– To work out the decline in value of depreciating assets
you held before 1 July 2001, you generally use the same
cost, effective life and method that you were using under
the former law
– The undeducted cost of the asset at 30 June 2001
becomes its opening adjustable value at 1 July 2001
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8.3 Methods of depreciation (cont…)
• Depreciation rates
– Rates of depreciation are fixed by reference to the effective
life of each asset
– The effective life of a particular item is the period for which
the item can reasonably be expected to be used in
producing assessable income
– The salvage value (or scrap value) of an asset is its
estimated value, if any, at the end of its effective life
– Once an asset has been depreciated, it is then said to have
a certain book value
Book value = original cost of asset – depreciation to date
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8.4 Prime cost method (straight line
method)
•
The prime cost method assumes that the value of a depreciating
asset decreases uniformly over its effective life
days held
100%
Annual depreciati on  asset' s cost 

365
asset' s effective life
•
•
Note that 365 is replaced by 366 in a leap year
The annual rate of depreciation (as a percentage) is given by:
Annual rate of depreciation 
annual depreciation
 100%
original value of asset
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8.4 Prime cost method (straight line
method) (cont…)
Example
Wendy purchased a photocopier for $1500 on 8 August 2009.
Determine the depreciation for this item for the 2009–10 income
year using the prime cost method.
Solution
From Table 8.2, the effective life of a photocopier is 5 years.
The number of days from 8 August 2009 to 30 June 2010
(inclusive) is 327
327 100%
Depreciation during 2009  10  $1500 

365
5
 $269
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8.5 Diminishing value method (reducing
balance method)
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The diminishing-value method assumes that the
depreciation of an asset is highest in the earliest years of its
life and calculates it as a fixed percentage of the preceding
book value
This is done because many assets (e.g. machines) are
more productive when new and become less efficient as
they get older
Depreciati on for year k  book value at e nd of k-1  depreciat ion rate
•
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Note that the book value at the end of year 0 is defined to
be the original cost
The depreciation rate represents the fraction of the book
value that is depreciated each year
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8.5 Diminishing value method (reducing
balance method) (cont…)
• For depreciating assets held initially prior to 10 May 2006 the
formula for the decline in value is:
Amount of depreciation 
opening adjusted value days held

 1.5
asset's effectivel ife
365
• For depreciating assets held initially after 10 May 2006, the
formula for the decline in value is:
Amount of depreciati on 
opening adjusted  value days held

 20
asset' s effectivel ife
365
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8.6 Units of production method
• The units of production method deals with items that
deteriorate more with use rather than age
• In this case, the effective life is determined by total output
rather than age
• Examples of items for which this method may well be
appropriate include
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tyres on a vehicle
machine parts
cutting blades
photocopiers
printers
or any items in continuous use
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8.6 Units of production method (cont…)
• The units-of-production method of depreciation is
similar to the prime-cost method, but the rate is
expressed as a usage rate rather than a time rate
original value of asset
Rate of depreciati on 
effective life in output ter ms
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8.7 Record keeping
•
If a deduction for depreciation is claimed in a tax
return, the following information must be kept:
– the undeducted cost and written-down (book) value of each
asset at the start of the income year
– for each asset disposed of during the year, the cost and
sale price, dates of acquisition and disposal, and the
undeducted cost and written-down value of the asset
– the adjustments made to cost, undeducted cost and writtendown value
– details of balancing charge relief, including the alternative
treatment of assessable adjustments
– the rate and amount of depreciation claimed for each asset
– the undeducted cost and written-down value of each asset
at the end of the income year
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Summary
•
We used the latest depreciation rules of the Australian Taxation
Office
•
We calculated depreciation using the prime cost (straight line)
method
•
We also calculated depreciation using the diminishing value
(reducing balance) method
•
And we calculated depreciation rates using the units-ofproduction method
•
We calculated the current written-down value (book value) of an
asset
•
Finally we looked at keeping depreciation records
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