D EPRECIATION & A SSET V ALUATION

D EPRECIATION What is it? “Annual loss in value due to use, wear, tear, age, & technical obsolescence.” Business expense reducing annual profit Factor that determines value for depreciable assets Loss in value resulting from use of an asset in production system

General Idea Asset has reduced life over time Its loss of value is a cost of production (business expense) Your taxes should reflect this So should your thinking Depreciation is a REAL cost If you ignore it you are fooling yourself Also when it wears out you must replace it – then what?

D EPRECIABLE A SSETS What are they? Must fulfill 3 requirements Useful life >1 year Determinable life, but not unlimited Use in a business Examples Machinery Buildings Breeding livestock Land improvements

C ALCULATING D EPRECIATION What must you know? Cost $ paid to put the asset into production Useful life Salvage value Another useful item to know Book value

D EPRECIATION M ETHODS Types Economic Tax How do you choose? What is your ultimate purpose? Management & decision making Completing tax forms

D EPRECIATION M ETHODS Economic Straight line Declining balance How do you choose? Total depreciation $ stays the same under both methods What type of asset is being depreciated?

S TRAIGHT L INE Annual depreciation (AD) = (cost – salvage value) / useful life OR AD = (cost – salvage value) * R R is annual straight line percentage rate = 100 % / useful life

E XAMPLE A seven year asset (planter) worth 10,000 with no salvage value Life =7 1/7 =

Period Book Value Period Start Depreciation Expense Accumulated Depreciation Book Value Period End 1 $10,000.00$1, $8, $1,428.57$2,857.14$7, $1,428.57$4,285.71$5, $1,428.57$5,714.29$4, $1,428.57$7,142.86$2, $1,428.57$8,571.43$1, $10,000.00$-0.00

D ECLINING B ALANCE (F AST D EPRECIATION ) AD = book value at beginning of year * R Common 150% Double (200%) Idea – greatest loss of value up front – car

E XAMPLE A seven year asset (planter) worth 10,000 with no salvage value Life =7 Double depreciation 2*1/7 =

Year Book Value Year Start Depreciation Percent Depreciation Expense Accumulated Depreciation Book Value Year End 1 $10, %$2, $7, %$2,040.82$4,897.96$5, %$1,457.73$6,355.69$3, %$1,041.23$7,396.92$2, %$743.74$8,140.66$1, %$531.24$8,671.90$1, %$379.46$9,051.35$948.65

Note – didn’t end up at zero Can use variable declining balance – take rest of value in last year Or switch to straight line when it is to your advantage

T AX D EPRECIATION Modified Accelerated Cost Recovery System (MACRS) IRS publications 225 & 946 Framework Implied salvage value = $0 ½ yr depreciation allowed in purchase year System of property classes determining useful life for the asset in question

Like double declining balance until straight line becomes better Year 1 – half a year Year 8 – half a year

Switch to straight line Remaining value/3.5years left

T AX D EPRECIATION Asset ClassExamples 3-yearBreeding hogs 5-yearTrucks, breeding cattle, sheep, dairy cows, computers 7-yearMost equipment & machinery, fencing, grain bins, office furnishings 10-yearSingle-purpose structures (milking parlor, greenhouses), fruit & nut trees 15-yearWells, drainage tile, 20-yearGeneral purpose buildings

E XAMPLE A small dairy processing cheese purchases a pasteurizer for their operation. This piece of equipment costs $27,900. In what class does this item fall? 7 year