LESSON 8-4 Other Methods of Depreciation 12/2/2018 LESSON 8-4 Other Methods of Depreciation RED

OTHER METHODS OF DEPRECIATION LESSON 8-4 OTHER METHODS OF DEPRECIATION 12/2/2018 page 242 Many plant assets depreciate more in the early years of useful life than in the later years. Charging more depreciation expense in the early years of a plant asset may be more accurate than caharging the same amount each year. Multiplying the book value at the end of each fiscal period by a constant depreciation rate is called the declining-balance method of depreciation Although the depreciation rate is the same each year, the annual depreciation expense declines from year to year RED

DECLINING-BALANCE METHOD OF DEPRECIATION LESSON 8-4 DECLINING-BALANCE METHOD OF DEPRECIATION 12/2/2018 page 242 The declining-balance depreciation rate is based on the straight-line rate. It is twice the straight-line rate (called the double declining-balance method) This method does not use the estimated salvage value to compute annual depreciation The estimated salvage value is used only to limit the last year’s depreciation expense A plant asset is never depreciated below its estimated salvage value RED

DECLINING-BALANCE METHOD OF DEPRECIATION LESSON 8-4 DECLINING-BALANCE METHOD OF DEPRECIATION 12/2/2018 page 242 The annual depreciation expense is calculated using the beginning book value for each year (beginning book value is the same as the ending book value from the previous year) Remember: Do not use salvage value in computing the book value Purchased a computer for $2,000 on January 1st. The computer has a useful life of 5 years and an estimated salvage value of $175 1. Calculate the declining-balance rate. Total Depreciation Expense 100%  Estimated Useful Life (years)  5 = Straight-Line Rate 20%  Double the Rate  2 = Declining-Balance Rate 40% 2. Calculate the annual depreciation for year 1. Beginning Book Value $2000  Depreciation Rate  40% = Annual Depreciation Expense $800 RED

DECLINING-BALANCE METHOD OF DEPRECIATION page 242 Plant asset: Computer Depreciation method: Declining balance Original cost: $2,000.00 Estimated salvage value: $175.00 Estimated useful life: 5 years Year Beginning Book Value Declining- Balance Rate Annual Depreciation Ending Book Value 1 2 3 4 5 Total Depreciation $2,000.00 1,200.00 720.00 432.00 259.20 40% — $ 800.00 480.00 288.00 172.80 84.20 $1,825.00 $1,200.00 175.00 1 2 1. Calculate the declining-balance rate. Total Depreciation Expense 100%  Estimated Useful Life (years)  5 = Straight-Line Rate 20%  Double the Rate  2 = Declining-Balance Rate 40% 2. Calculate the annual depreciation for year 3. Beginning Book Value $720  Depreciation Rate  40% = Annual Depreciation Expense $288 LESSON 8-4

SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATION LESSON 8-4 SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATION 12/2/2018 page 243 Another method of calculating depreciation is based on a fraction derived from the years’ digist for the useful life of a plant asset Using fractions based on the number of years of a plant asset’s useful life is called the sum-of-the-years’-digits method of depreciation Like the straight-line method, the estimated salvage value is subtracted from the original cost to compute an estimated total depreciation expense This results in a last year ending book value equal to the palnt asset’s salvage value RED

SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATION LESSON 8-4 SUM-OF-THE-YEARS’-DIGITS METHOD OF DEPRECIATION 12/2/2018 page 243 The fractions are determined as follows: The years’ digits are added (1+2+3+4+5 = 15 Then, using the sum of the years’ digits, a fraction is created for each year with the years’ digits in reverse order The sum-of-the-years’-digits method results in a last year ending book value equal to the plant asset’s salvage value 1. Calculate the fraction. Years’ Digits Fraction 1 5/15 2 4/15 3 3/15 4 2/15 5 1/15 15 RED

SUM-OF-THE-YEARS-DIGITS METHOD OF DEPRECIATION page 243 Plant asset: Computer Depreciation method: Sum-of-the-years-digits Original cost: $2,000.00 Estimated salvage value: $175.00 Estimated useful life: 5 years Year Beginning Book Value Fraction Total Depreciation Annual Depreciation Ending Book Value 1 2 3 4 5 Total $2,000.00 1,391.67 905.00 540.00 296.67 5/15 4/15 3/15 2/15 1/15 $1,825.00 $608.33 486.67 365.00 243.33 121.67 $1,391.67 175.00 1 2 1. Calculate the fraction. Years’ Digits Fraction 1 5/15 2 4/15 3 3/15 4 2/15 5 1/15 15 2. Calculate the annual depreciation for year 1. Original Cost $2,000.00 Estimated Salvage Value – 175.00 Estimated Total Depreciation $1,825.00 Year’s Fraction  5/15 Annual Depreciation $608.33 LESSON 8-4

COMPARISON OF THREE METHODS OF DEPRECIATION page 244 Plant asset: Computer Depreciation method: Comparison Original cost: $2,000.00 Estimated salvage value: $175.00 Estimated useful life: 5 years Year Straight-Line Method Double Declining-Balance Method Sum-of-the-Years-Digits Method 1 2 3 4 5 Total Depreciation $365.00 365.00 $1,825.00 $ 800.00 480.00 288.00 172.80 84.20 $608.33 486.67 243.33 121.67 Regardless of the depreciation method used, the total depreciation expense over the useful life of an asset is the same Double declining balance method & sum-of-the-years’-digits are known as accelerated depreciation methods LESSON 8-4

PRODUCTION-UNIT METHOD OF DEPRECIATION LESSON 8-4 PRODUCTION-UNIT METHOD OF DEPRECIATION 12/2/2018 page 245 Sometimes the useful life of a plant asset depends on how much the asset is used Ex. Automobile will wear out faster if it is driven 80,000 miles a year rather than 60,000 miles. Calculating estimated annual depreciation expense based on the amount of production expected from a plant asset is called the production-unit method of depreciation The depreciation rate for the asset is calculated by dividing the estimated total depreciation expense by the estimated useful life 1. Calculate the depreciation rate. Original Cost $18,200 – Estimated Salvage Value – 2,000 = Est. Total Depreciation Expense $16,200  Estimated Useful Life (miles)  90,000 = Depreciation Rate $0.18/mile RED

PRODUCTION-UNIT METHOD OF DEPRECIATION page 245 Plant asset: Truck Depreciation method: Production-unit Original cost: $18,200.00 Estimated salvage value: $2,000.00 Estimated total depreciation: $16,200.00 Estimated useful life: 90,000 miles Depreciation rate: $0.18 per mile driven Year Beginning Book Value Miles Driven Annual Depreciation Ending Book Value 1 2 3 4 5 Totals $18,200.00 16,580.00 12,440.00 7,940.00 3,980.20 9,000 23,000 25,000 22,000 8,000 87,000 $ 1,620.00 4,140.00 4,500.00 3,960.00 1,440.00 $15,600.00 $16,580.00 2,540.00 1 2 1. Calculate the depreciation rate. Original Cost $18,200 – Estimated Salvage Value – 2,000 = Est. Total Depreciation Expense $16,200  Estimated Useful Life (miles)  90,000 = Depreciation Rate $0.18/mile 2. Calculate annual depreciation for year 1. Total Miles Driven 9,000  Depreciation Rate  $0.18 = Annual Depreciation Exp. $1,620.00 LESSON 8-4

CALCULATING DEPRECIATION EXP. FOR INCOME TAX PURPOSES LESSON 8-4 CALCULATING DEPRECIATION EXP. FOR INCOME TAX PURPOSES 12/2/2018 page 246 Modified Accelerated Cost Recovery System is a depreciation method required by the Internal Revenue Service to be used for income tax calculation purposes for most plant assets placed in service after 1986. This method is generally referred to as MACRS. MACRS has prescribed periods for nine classes of useful life for plant assets. An asset is assigned to a specific class based on its characteristics and general life expectancy. RED

TERMS REVIEW declining-balance method of depreciation page 248 declining-balance method of depreciation sum-of-the-years’-digits method of depreciation production-unit method of depreciation Modified Accelerated Cost Recovery System LESSON 8-4