Chapter 3 Part 2

Depreciation Depreciation = loss of value (ex. Driving a car off the lot) Accounting depreciation, reflects the use of an asset during a period Cost of using the asset in the year = Income statement Reduction in the value = Balance sheet

Table 3-5: Calculating straight-line depreciation Simplest way is straight-line depreciation Full-historical costs of the asset (purchase price + delivery, installation, etc.) Then subtract the expected salvage value at the end of the asset’s useful life Divided by the number of years in the asset’s useful life

Example straight-line Computer $6,000 (historical costs) Computer have a life of 3 years Salvage value = 0 Annual depreciation is $2,000 Historical cost of asset $6,000.00 Minus salvage value 0.00 Total $6,000 Divided by estimated useful life 3 Annual depreciation expense $2,000

Caveat Organization subject to income taxation will not want to use straight-line depreciation Depreciation is an expense that is deducted from net income for calculating tax liability, those organizations that are subject to income taxation can lower bills by increasing depreciation expense IRS allows use of accelerated depreciation for organizations by using Modified Accelerated Cost Recovery Systems (MACRS) table = gives more useful ways to calculate depreciation Push-Pull Should I use depreciation to lower tax rate or not use to show better profit Use both to demonstrate what’s going on Taxes and shareholders, etc.  deferred tax liability

MACRS MACRS = MODIFIED ACCELERATED COST RECOVERY SYSTEM = Allows for greater accelerated depreciation over longer time periods.

MACRS TABLE HOW TO USE THE MACRS TABLE RECOVERY YEAR = CLASSES OF PROPERTY 1ST YEAR X% 2ND YEAR X% ETC.

EXAMPLE SALVAGE VALUE IS NOT CONSIDERED – IN ADDITION, A 5-YEAR PRODUCT IS DEPRECIATED FOR 6 YEARS; A 4-YEAR PRODUCT IS DEPRECIATED FOR 5 YEARS; ETC. Year 3-year 5-year 7-year 10-year 1 33.3 20 14.3 10 2 44.5 32 24.5 18 3 14.8 19.2 17.5 14.4 4 7.4 11.5 12.5 5   8.9 9.2 6 5.8 7 6.6 8 4.5 9 6.5 11 3.3

Calculating 3-YEAR depreciation under MACRS 1 33.3 20 14.3 10 2 44.5 32 24.5 18 3 14.8 19.2 17.5 14.4 4 7.4 11.5 12.5 5   8.9 9.2 6 5.8 7 6.6 8 4.5 9 6.5 11 3.3 Historical cost of asset $6,000.00 Multiplied by the first-year MACRS (table 3-7 pg. 46) 0.333 Annual depreciation expense – YEAR 1 $1,998 Historical cost of asset $6,000.00 Multiplied by the 2ND -year MACRS (table 3-7 pg. 46) 0.445 Annual depreciation expense –YEAR 2 $2,670 Historical cost of asset $6,000.00 Multiplied by the 3RD -year MACRS (table 3-7 pg. 46) 0.148 Annual depreciation expense –YEAR 2 $888 Historical cost of asset $6,000.00 Multiplied by the 4TH -year MACRS (table 3-7 pg. 46) 0.074 Annual depreciation expense –YEAR 2 $444