DEPRECIATION Chapter Seventeen Copyright © 2014 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin

Explain the concept and causes of depreciation. 2. Prepare a depreciation schedule and calculate partial-year depreciation. LU 17-1: Concepts of Depreciation and the Straight-Line Method LEARNING UNIT OBJECTIVES LU 17-2: Units-of-Production Method 1. Explain how use affects the units-of-production method. 2. Prepare a depreciation schedule. LU 17-3: Declining-Balance Method 1. Explain the importance of residual value in the depreciation schedule. 2. Prepare a depreciation schedule. LU 17-4: Modified Accelerated Cost Recovery System (MACRS) with Introduction to ACRS 1. Explain the goals of ACRS and MACRS and their limitations. 2. Calculate depreciation using the MACRS guidelines.

17-3 ACCOUNTING EQUATION AND BALANCE SHEET Balance Sheet: Gives a financial picture of what a company is worth as of particular date. AssetsLiabilities + Owner’s Equity = (How much the company owns) (How much the owner is worth) (How much the company owes) Accounting Equation: Assets = Liabilities + Owner’s Equity

17-4 Estimated Useful Life – Number of years or time periods for which the company can use the asset Depreciation – An estimate of the use or deterioration of an asset Asset Cost – Amount paid for an asset including freight charges CONCEPT OF DEPRECIATION Accumulated Depreciation – The total amount of the asset’s depreciation taken to date

17-5 Residual Value (Salvage Value) - Expected cash value at the end of an asset’s useful life. CONCEPT OF DEPRECIATION Book Value - The unused amount of the asset cost that may be depreciated in future accounting periods. Book value cannot be less than residual value. Book value = Asset cost -- Accumulated book value

17-6 CAUSES OF DEPRECIATION Product ObsolescencePhysical Deterioration

17-7 STRAIGHT-LINE METHOD Distributes the same amount of expense to each period of time. Depreciation expense = Cost -- Residual value each year Estimated useful life in years Ajax Company buys equipment, the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule. $2, $ % = 100% # of yrs. 5 = $400= 20% Example:

17-8 DEPRECIATION SCHEDULE

17-9 DEPRECIATION FOR PARTIAL YEARS Assume Ajax Company bought equipment for $2,500. The estimated useful life is five years. The residual value is $500. What would be depreciation for the first year? Depreciation expense each year = $2, $500 = 5 15th Rule May, June, July, Aug, Sept., Oct., Nov., & Dec. Cost -- Residual value Estimated useful life in years $400 x 8 = $

17-10 UNITS-OF-PRODUCTION METHOD Depreciation determined by how much the company uses the asset. Depreciation expense = Cost -- Residual value per unit Total estimated units produced Ajax Company (in Learning Unit 17–1) buys equipment, and the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule. Depreciation = Unit x Units amountdepreciation produced Example:

17-11 DEPRECIATION SCHEDULE

17-12 Rate = 100% 5 years Ajax Company (in Learning Unit 17–1) buys equipment, and the company estimates how many units the equipment can produce. Let’s assume the equipment has a useful life of 4,000 units. After 5 years the residual value is $500. Calculate depreciation expense and complete a depreciation schedule. Depreciation expense = Book value of equipment x Depreciation each year at beginning of year rate Accelerated method which computes more depreciation expense in the early years of the asset’s life. Uses up to twice the straight-line rate. DECLINING-BALANCE METHOD x 2 = 40% Example:

17-13 DEPRECIATION SCHEDULE

17-14 MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) Federal tax laws state how depreciation must be taken for income tax purposes. Provides users with tables giving the useful lives of various assets and the depreciation rates.

17-15 KEY POINTS OF MACRS 1. It calculates depreciation for tax purposes. 2. It ignores residual value. 3. Depreciation in the first year (for personal property) is based on the assumption that the asset was purchased halfway through the year. (A new law adds a midquarter convention for all personal property if more than 40% is placed in service during the last 3 months of the taxable year.) 4. Classes 3, 5, 7, and 10 use a 200% declining-balance method for a period of years before switching to straight-line depreciation. You do not have to determine the year in which to switch since Table 17.6 builds this into the calculation. 5. Classes 15 and 20 use a 150% declining-balance method before switching to straight-line depreciation. 6. Classes 27.5 and 31.5 use straight-line depreciation.

17-16 MODIFIED ACCELERATED COST RECOVERY SYSTEM (MACRS) (TABLE 17.4)

17-17 ANNUAL RECOVERY FOR MACRS (TABLE 17.5)

17-18 DEPRECIATION SCHEDULE