CTC 475 Review Cost Estimates

CTC 475 Depreciation

Objectives Know the historical (SL, DB, SYD) and MACRS methods to determine book values and depreciation

Tax Concepts Taxes affect cash flows Depreciation affects taxes Depreciation method is determined by law: Post ’86-MACRS (Modified Accelerated Cost Recovery System) ’81-’86 ACRS (Accelerated Cost Recovery System) Pre ’81-other methods (SL, DB, SYD) SL-straight line; DB-declining balance; SYD-sum of the year’s digits

Depreciable Property 3 Requirements Must be used in business or held for the production of income Life can be determined and is longer than one year Must be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes

Depreciable Property Tangible (machines, cars, computers) Intangible (copyrights, franchises) Real (erected on land, growing on land, attached to land; however, land itself is not depreciable) Personal (machines, cars) Most depreciable property is tangible, personal

Adjusted Cost Basis Cost of property + Cost of additions + Installation cost

Book Value The worth of a depreciable property as shown on the accounting records

Recovery Period Time over which cost basis can be recovered For MACRS law sets as 3,5,7,10,15, or 20 (for tangible property) 27.5 (for residential real property) 31.5/39 years (for nonresidential real property) Refer to Table 12.2 (MACRS depletion rates) and Table 12.4 (Example recover periods) The recovery period is usually shorter than the actual physical life

Examples 3-year property 5-year property 7-year 10-year property Tractor units, special tools, race horses 5-year property Autos, buses, computers, office machinery 7-year Office furniture, theme/amusement park assets 10-year property Vessels, tugs, assets used in petroleum refining 15-year property Sewage treatment plants, sidewalks, roads, drainage facilities bridges, fencing, landscaping, transmission lines 20-year property Farm buildings

Depreciation Methods SL-straight line DB-declining balance SYD-Sum of the years digits MACRS, modified accelerated cost recovery system

Depreciation Methods-Example 7-year property Basis is $100K SV=0

SL Example Depreciation is 1/7 (14.28%) * Cost Basis 14.28% * $100K = $14,286

Straight Line Method EOY Depreciation Book Value - $100K 1 $14,286 - $100K 1 $14,286 $85,714 2 $71,428 3 $57,142 4 $42,856 5 $28,570 6 $14,285 7

What’s Wrong with this Method?

DB Example Cost Basis is $100K Depreciable Life is 7 years 200% DB---- Depreciation is 2/7 (28.56%) * Book Value of previous year 150% DB----(not used for this example) Depreciation would be 1.5/7 * Book Value of previous year

Declining Balance Method EOY Depreciation Book Value - $100K 1 28.56%*$100K=$28,560 $71,440 2 28.56%*$71,440=$20,403 $51,036 3 28.56%*$51,036=$20,403 $36,460 4 28.56%*$36,460=$10,413 $26,047 5 28.56%*$26,047=$7,439 $18,608 6 28.56%*$18,608=$5,314 $13,294 7 28.56%*$13,294=$3,797 $9,497

What’s Wrong with this Method?

SYD Example Cost Basis is $100K Depreciable Life is 7 years Number the depreciable life years in reverse order Sum up the numbers Year/Sum=Depreciation Amount applied to cost basis

SYD Method Year Reverse Order Depreciation Rate 1 7 7/28=25% 2 6 6/28=21.4% 3 5 5/28=17.8% 4 4/28=14.3% 3/28=10.7% 2/28=7.1% 1/28=3.5% Sum=28 Sum=100%

SYD Method EOY Depreciation Book Value - $100K 1 $25,000 $75,000 2 - $100K 1 $25,000 $75,000 2 $21,428 $53,572 3 $17,857 $35,715 4 $14,286 $21,429 5 $10,714 $10,715 6 $7,143 $3,572 7

MACRS 3,5,7,10 yr (200% DBSLH) 15, 20 yr (150% DBSLH) DBSLH (Declining Balance switching to Straight-Line depreciation at the optimum time with a Half-year convention) See table 12.2 for depreciation rates which are multiplied by the cost basis Note that the half-year convention extends depreciation rate one year beyond the recovery period (ex 4 vs 3 year)

MACRS Method EOY Depreciation Book Value - $100K 1 - $100K 1 14.29%*$100K=$14,290 $85,710 2 24.49%*$100k=$24,490 $61,220 3 17.49%*$100K=$17,490 $43,730 4 12.49%*$100K=$12,490 $31,230 5 8.93%*$100K=$8,930 $22,310 6 8.92%*$100K=$8,920 $13,390 7 $4,460 8 4.46%*$100K=$4,460 $0

Next lecture Taxes ATCF’s taking into account depreciation