McGraw-Hill/Irwin ©2011 The McGraw-Hill Companies, All Rights Reserved Chapter 17 Depreciation

Explain the concept and causes of depreciation 2. Prepare a depreciation schedule and calculate partial-year depreciation Depreciation #17 Learning Unit Objectives Concepts of Depreciation and the Straight-Line Method LU17.1

Explain how use affects the units-of- production method 2. Prepare a depreciation schedule Depreciation #17 Learning Unit Objectives Units-of-Production Method LU17.2

Explain the importance of residual value in the depreciation schedule 2. Prepare a depreciation schedule Depreciation #17 Learning Unit Objectives Declining-Balance Method LU17.3

Explain the goals of ACRS and MACRS and their limitations 2. Calculate depreciation using the MACRS guidelines Depreciation #17 Learning Unit Objectives Modified Accelerated Cost Recovery System (MACRS) with Introduction to ACRS LU17.4

17-6 Estimated Useful Life - Number of years or time periods for which the company can be 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

17-7 Residual Value (Salvage Value) - Expected cash value at the end of an assets useful life. Concept of Depreciation Book Value - The unused amount of the asset cost that may be depreciated in future accounting periods Book Value = Asset cost - Accumulated Book value Book value cannot be less than residual value

17-8 Causes of Depreciation Product ObsolescencePhysical Deterioration

17-9 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. $2,500 - $500 = $ % = 100% = 20% # of yrs. 5

17-10 Depreciation Schedule Book value at end DepreciationAccumulatedof year (Cost - End of Cost ofexpense fordepreciationAccumulated year equipment yearat end of yeardepreciation) 1 $2,500$400$ 400$2,100 2 $2,500$400$ 800$1,700 3 $2,500$400$1,200$1,300 4 $2,500$400$1,600$ $2,500$400$2,000$ 500 Equals Residual Value

17-11 Depreciation for Partial Years Assume Ajax Company bought equipment for $2,500. What would be depreciation for the first year? The estimated useful life is five years. Depreciation expense = Cost - Residual value each year Estimated useful life in years $2,500 - $500 = $400 x 8 = $ th Rule May, June, July, Aug, Sept., Oct., Nov., & Dec.

17-12 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, 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 amount depreciation produced

17-13 Depreciation Schedule DepreciationAccumulated Book value End of Cost ofUnitsexpense fordepreciation at end year equipmentprod. yearat end of year of year 1 $2, $150$ 150$2,350 2 $2, $200$ 350$2,150 3 $2, $300$ 650$1,850 4 $2,500 2,000 $1,000$1,650$ $2, $350$2,000$ 500 $2,500 - $500 = $.50 per unit 4, x $.50

17-14 Rate = 100% x 2 = 40% 5 years Ajax Company (in Learning Unit 17–1) 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. Depreciation expense = Book value of equip. 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

17-15 Depreciation Schedule Accumulated Book value at DepreciationAccumulated Book value End of Cost of depreciation beginning expense fordepreciation at end year Truck at beg. of year of year yearat end of year of year 1 $2,500 0 $2,500 $1,000 $1,000 $1,500 2 $2,500$1,000 $1,500 $ 600 $1,600$ $2,500$1,600 $ 900 $ 360 $1,960$ $2,500$1,960 $ 540 $ 40 $2,000$ $2,500$2,000 $ 500 $ 0 $2,000$ 500 $1,500 x.40 Rate = 100% x 2 = 40% 5 years

17-16 Modified Accelerated Cost Recovery System (MACRS) with Introduction to (ACRS) 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

17-17 Key points of MACRS 1. It calculates depreciation for tax purposes. 2. It ignores residual value. 3. Depreciation if 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.

17-18 Table Modified Accelerated Cost Recovery System (MACRS) Class recovery Period (life)Asset types 3-yearRacehorses more than 2 years old or any horse other than a racehorse that is more than 12 years old at the time place into service special tools of certain industries. 5-yearAutomobiles (not luxury) taxis; light general purpose trucks; semiconductor manufacturing equipment computer-based telephone central-office switching equipment qualified technological equipment; property used in connection with research and experimentation. 7-yearRailroad track single-purpose agricultural (pigpens), or horticultural; structures; fixtures; equipment; furniture. 10-yearNew law doesn’t add any specific property under this class. 15-yearMunicipal wastewater treatment plants; telephone distribution plants and comparable equipment used for two-way exchange of voice and data communications. 20-yearMunicipal sewers yearOnly residential property yearOnly nonresidential real property.

17-19 Table Annual Recovery for MACRS

17-20 Depreciation Schedule DepreciationAccumulatedBook value End of Cost ofexpense fordepreciation at end year equipment yearat end of year of year 1 $2,500$500$500$2,000 ($2,500 x.20) 2 $2,500$800$1300$1,200 ($2,500 x.32) 3 $2,500$480$1,780$ $2,500$288$2,068$ $2,500$288$2,356$ $2,500$144$2,500$ 0