8-1 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e Chapter 8 Depreciation Introductory Mathematics & Statistics

8-2 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e Learning Objectives Use the latest depreciation rules of the Australian Taxation Office Calculate depreciation using the prime cost (straight line) method Calculate depreciation using the diminishing value (reducing balance) method Calculate depreciation rates using the units-of-production method Prepare a depreciation schedule Calculate the current written-down value (book value) of an asset Keep depreciation records

8-3 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.1 Introduction Depreciable assets –The value of an asset gradually reduces over time as it approaches the end of its useful life. Assets that lose value in this way are said to depreciate –The amount of this lost value is called depreciation and represents a depreciation expense –The assets themselves are known as depreciable assets, and each one has limited effective life

8-4 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.1 Introduction (cont…) Possible causes of depreciation include –physical deterioration –obsolescence –inadequacy –lack of utility –exhaustion –the passage of time The cost of an item for depreciation purposes includes: –the original purchase price or construction cost –transport costs –installation costs –customs duty –relocation costs

8-5 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.1 Introduction (cont…) The depreciation provisions apply to plant, which means articles or assets that are used to produce assessable income, or are installed ready for use to produce income and are held in reserve. Examples include: –computers –electrical tools –furniture and fittings –furnishings –manufacturing machinery –motor vehicles

8-6 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.1 Introduction (cont…) Simplified depreciation rules –If you choose to use the simplified depreciation rules, you must use them to work out deductions for all your depreciating assets that the rules apply to –You can pool into a general small business pool and deduct at the rate of 30% most other depreciating assets with effective lives of less than 25 years –If the depreciating assets have effective lives of 25 years or more they can be pooled into a long-life small business pool and deducted at the rate of 5%

8-7 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system The simplified (depreciation) rules under the simplified tax system (STS) provide small businesses with significant concessions These rules involve simpler calculations and remove the need to calculate depreciation separately for each asset Under the simplified depreciation rules, you can claim an immediate deduction for most depreciating assets costing less than $1000 and pool most other depreciating assets

8-8 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system (cont…) Small business pools –You may combine assets into small business pools as follows: the general small business pool—for assets with effective lives of less than 25 years the long-life small business pool—for assets with effective lives of 25 years or more –If you held any assets at the start of the income year that you chose to use these rules, you must generally allocate them to a pool at the beginning of that year –The opening pool balance is the taxable-purpose proportion of the adjustable values of all depreciating assets in your pool

8-9 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system (cont…) Using the simplified depreciation rules for the first time –When you first use the simplified depreciation rules, you must work out each pool’s opening balance –In later years, you must review, and in some cases adjust, the opening pool balance for the changes to taxable purpose proportion before working out your pool deduction

8-10 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system (cont…) Continuing to use the simplified depreciation rules –In later years, you may need to adjust the opening pool balance before calculating your pool deduction if you:  change the extent to which you use a pooled asset for a taxable purpose, or  have assets that you started to use, or hold ready to use, since last choosing to use these rules –The adjustment will ensure that your pool deduction is based on the correct estimate of the adjustable value of all your assets and their taxable-purpose proportions for the current and future income years

8-11 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system (cont…) Adjustable value –You must work out the adjustable value of each depreciating asset you start to use, or have installed ready to use, for a taxable purpose –The adjustable value of an asset is its cost less its decline in value since you first used it –The asset’s cost does not include any amount that you can claim as a GST credit

8-12 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.2 The simplified tax system (cont…) Low-cost assets –A low-cost asset is one whose cost at the end of the year you first used it for a taxable purpose is less than $1000 (Note: This definition excludes horticultural plants) –You use an asset for a taxable purpose if you use it to produce assessable income –You can claim an immediate deduction for low-cost assets in the income year that you first use those assets, for a taxable purpose

8-13 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.3 Methods of depreciation You can work out the decline in value of a depreciating asset using either the prime-cost method (also known as the straight-line method) or the diminishing-value method (also known as the reducing-balance method) Once a particular method of depreciation for an item is adopted, you may not change to the other method for that item For most depreciating assets, you can choose whether to self-assess the effective life or adopt the taxation Commissioner’s determination

8-14 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.3 Methods of depreciation (cont…) Non-business use –A deduction for the decline in value of a depreciating asset is not allowable if the depreciating asset is used solely for private purposes Assets held at the start of the year –How you apply the simplified depreciation rules to depreciate assets that you held at the start of the year depends on whether this is the first year you are using the rules or whether you have used them in a previous year

8-15 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.3 Methods of depreciation (cont…) Depreciating assets held before 1 July 2001 –To work out the decline in value of depreciating assets you held before 1 July 2001, you generally use the same cost, effective life and method that you were using under the former law –The undeducted cost of the asset at 30 June 2001 becomes its opening adjustable value at 1 July 2001

8-16 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.3 Methods of depreciation (cont…) Depreciation rates –Rates of depreciation are fixed by reference to the effective life of each asset –The effective life of a particular item is the period for which the item can reasonably be expected to be used in producing assessable income –The salvage value (or scrap value) of an asset is its estimated value, if any, at the end of its effective life –Once an asset has been depreciated, it is then said to have a certain book value Book value = original cost of asset – depreciation to date

8-17 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.4 Prime cost method (straight line method) The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life Note that 365 is replaced by 366 in a leap year The annual rate of depreciation (as a percentage) is given by:

8-18 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.4 Prime cost method (straight line method) (cont…) Example Wendy purchased a photocopier for $1500 on 8 August Determine the depreciation for this item for the 2009–10 income year using the prime cost method. Solution From Table 8.2, the effective life of a photocopier is 5 years. The number of days from 8 August 2009 to 30 June 2010 (inclusive) is 327

8-19 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.5 Diminishing value method (reducing balance method) The diminishing-value method assumes that the depreciation of an asset is highest in the earliest years of its life and calculates it as a fixed percentage of the preceding book value This is done because many assets (e.g. machines) are more productive when new and become less efficient as they get older Note that the book value at the end of year 0 is defined to be the original cost The depreciation rate represents the fraction of the book value that is depreciated each year

8-20 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.5 Diminishing value method (reducing balance method) (cont…) For depreciating assets held initially prior to 10 May 2006 the formula for the decline in value is: For depreciating assets held initially after 10 May 2006, the formula for the decline in value is:

8-21 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.6 Units of production method The units of production method deals with items that deteriorate more with use rather than age In this case, the effective life is determined by total output rather than age Examples of items for which this method may well be appropriate include –tyres on a vehicle –machine parts –cutting blades –photocopiers –printers –or any items in continuous use

8-22 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.6 Units of production method (cont…) The units-of-production method of depreciation is similar to the prime-cost method, but the rate is expressed as a usage rate rather than a time rate

8-23 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e 8.7 Record keeping If a deduction for depreciation is claimed in a tax return, the following information must be kept: –the undeducted cost and written-down (book) value of each asset at the start of the income year –for each asset disposed of during the year, the cost and sale price, dates of acquisition and disposal, and the undeducted cost and written-down value of the asset –the adjustments made to cost, undeducted cost and written- down value –details of balancing charge relief, including the alternative treatment of assessable adjustments –the rate and amount of depreciation claimed for each asset –the undeducted cost and written-down value of each asset at the end of the income year

8-24 Copyright  2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e Summary We used the latest depreciation rules of the Australian Taxation Office We calculated depreciation using the prime cost (straight line) method We also calculated depreciation using the diminishing value (reducing balance) method And we calculated depreciation rates using the units-of- production method We calculated the current written-down value (book value) of an asset Finally we looked at keeping depreciation records