17 depreciation

8/3/2019 17 Depreciation

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17 Depreciation

Based on: Engineering Economic Analysis, 10th ed.


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Depreciation

Defined as a decrease in value.

Decrease in market value of an asset.

Decrease in value of an asset to its owner.

Systematic allocation of an assets cost over its depreciable

life

Forms of depreciation

Deteriorationrefers to the process of wear out and no

longer performing a function as well as when new.

Obsolescencethe continuing stream of newer models

makes older ones obsolete.


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Depreciation vs. Expenses

Business costs are generally either expensed or

depreciated.

Expensed costsare part of regular business

operations.

Labor, utilities, materials, insurance.

Reduce income taxes because one can write them off when they

occur.


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Depreciation vs. Expenses

Depreciatedbusiness costs related to capital

assets losing value over time. A non cash cost

that requires no exchange of dollars. Buildings, forklifts, chemical plants.

Written off over its depreciable life.

Depreciable life determined by the method used to

spread the cost.

Reduce the taxable income of businesses.

Must be considered in an after-tax analysis.


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Depreciable Assets

1. The property must be used for business purposes

to produce income.

2. The property must have a useful life that can be

determined, and this life must be longer than a

year.

3. The property must be an asset that decays, gets

used up, wears out, becomes obsolete, or loses

value to the owner.


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Expensed or Depreciated Cost?

1. Cost of pizza dough and toppings

2. Cost to pay wages for janitor

3. Cost of a new baking oven

4. Cost of new delivery van

5. Cost of furnishings in dining room

6. Utility costs for soda refrigerator

Depreciated: 3, 4, 5


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Types of Property

Tangible assets can be seen, touched, and felt.

Tangible property includes:

Real property - land, buildings, and all things growing

on, built upon, constructed on, or attached to the

land.

Personal property - equipment, furnishings, vehicles,

office machinery, and anything that is tangible

excluding assets defined as real property.


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Depreciable Property

Tangible properties used in both business and

personal activities can be depreciated, but only

in proportion to the use for business purposes.

Almost all tangible property can be depreciated.

There are some exceptions.


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1. Land

2. Expenses for clearing, grading, preparing, planting,

and landscaping.

Have no fixed useful life.

3. Factory inventory and containers considered as

inventory.

4. Leased property.

Only the real owner of property may claim depreciation

expenses.

Non-Depreciable Property


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General Depreciation

0

0.2

0.4

0.6

0.8

1

1.2

0 1 2 3 4 5 6

BookValue

Depreciable Life (Years)

Depends on the model


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Book Value

Asset Cost Depreciation Charges to Date

Cost basis =

= sum of depreciation deductions taken from time 0 to time t depreciation deduction in Year


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Straight Line Depreciation

Annual Depreciation Charge

Total amount to be depreciated, , is divided bythe depreciable life, in years, :

where: ( ).

,


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Example: Straight Line Depreciation

Suppose you intend to purchase a device that costs

$900 with a $70 salvage value at the end of its 5-yr

depreciable life. What is the straight-line depreciation

schedule?

Year, 1 $166 $900 $166 $7342 166 734 166 5683 166 568 166 4024 166 402 166 2365 166 236 166 70

90070

5 166


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Sum-of-Years-Digits Depreciation

(SOYD)

This method results in larger-than-straight-line

depreciation charges during an assets early years and

smaller charges as the asset nears the end of its

depreciable life.

The depreciation charge per year equals a fraction of

the total amount to be depreciated ( ).

The depreciation charge shrinks by one over the sum of

the years digits.


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Sum-of-Years-Digits Depreciation

+ 1

number of years in depreciable life years (+1)/2 cost of asset salvage life


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Example: SOYD



depreciable life. What is the SOYD schedule?

Year,

1 $277 $900 $277 $6232 221 623 221 4023 166 402 166 2364 111 236 111 1255

55

1 2 5 5 5 7 0

5 62 15 + 1

5 1 + 1

15 900 70 277


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Declining Balance Depreciation

Applies a constant depreciation rate to the propertys

declining book value.

The depreciation rate is often 150% or 200%, although,

other constant rates are also feasible.

When the rate is 200%, the method is called Double

Declining Balance.


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Double Declining Balance Depreciation

(DDBD)

Applies a constant depreciation rate (200%) to the

propertys declining book value.

= =

number of years in depreciable life years cost of asset

= depreciation charges to date


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Example: Double Declining Balance



depreciable life. What is the DDBD schedule?

Year,

1 $360 $900 $360 $5402 216 540 216 3243 130 324 130 1944 78 194 78 1165

46

1 1 6 4 6 7 0

2 5 900 $360 2 5 900 360 $216


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Method Comparison

Depreciation Schedule

Book Value

Year, SLD SOYD DDBD1 $166 $277 $360

2 166 221 216

3 166 166 130

4 166 111 78

5 166 55 46

Year, SLD SOYD DDBD1 $734 $623 $5402 568 402 324

3 402 236 194

4 236 125 116

5 70 70 70


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Modified Accelerated Cost Recovery

System (MACRS)

Depreciation method established by the Taxpayer Relief Act

of 1997.

Uses a combination of declining balance and straight line

depreciation.

Must assign each asset into a class.

Classes define the assets depreciable life and which methodapplies for a particular range of that depreciable life.

All assets start depreciating according to DDBD and later

on convert to SLD.

17 depreciation

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