ISEN 302 Test 3 Annet Rodgers

Basic Aspects of depreciation

Decline in market value of an asset due to deterioration or obsolescence, decline in value of an asset to its owner, or systematic allocation of an asset costs over its useful or depreciable life(accountants definition). Can be calculated using a method for taxes, another method for valuation

Firms can depreciate...

Tangible property(forklifts, computers, buidlings)

Intangible assets can be

Amortized over time(patents, copyrights, licenses...)

Intangible property accounts for what amount of total typical us Firm?

80%

Expenses(costs)

Part of rugular business operation, consumed over short period of time, can be recurring, do not lose value over time, are subtracted from revenues, reduce income taxes as they can be written off, cannot be depreciated

examples of expenses(costs)

labor, utilities, materials, insurance...

depreciation

capital assets are not written off as expenses, capital assets lose value gradually over time(depreciate), can be written off over the depreciable life of asset or recovery period, reduce taxable income, non-cash cost

examples of depreciable assets

building, plants, machines...

GAAP

Generally accepted accounting principles, Common set of accounting rules, standards, and procedures issued by FASB. Public companies are required to follow GAAP when compiling Financial statements.

Basic requirements for depreciation

Is depreciable if: Used for business purposes to produce income, useful life is longer than a year, asset decays wears out loses value from natural causes(only the property owner can claim depreciation expenses.)

Not depreciable: Land, inventory, leased property, only used partly by the business or used for personal use.

Types of property

Tangible property and Intangible property

tangible property

real property(land, buildings, things growing on, built upon, constructed on, or attached to land)

intangible property

Property that has value but cannot be directly seen or touched; examples are patents, copyrights, trademarks

Deprecaition for tangible property

Almost all tangible property can be depreciated(not land, factory inventory, containers considered inventory, and leased property)

If property is used for personal and business only the percentage used for business is able to be depreciated

depreciation for intangible property

can be generally depreciated

book Value

cost bases - depreciation changes made to date

BVt

Book value at end of time t

BVt =

Cost Basis - sum of depreciation from year 1 to end of life

Cost Basis

dollar amount being depreciated including the asset purchase price and any other costs necessary to make the asset ready to use

Depreciated recapture(ordinary gains)

assets sold for more than book value but less than original basis

Losses

assets sold for less than book value

capital gains

assets sold for more than original cost basis(rare, common for stocks, bonds, real estate, art...) gains are taxed at lower rate

Straight line(Sl), declining balance(DB)

used for valuation, used for creating MACRS depreciation tables for taxes

Sum of the years digist(SOYD), sinking fund

Used less often

Straight-line(SL) dt(Depreciation charge in year t) =

B(cost of asset made ready to use)-S(Salvage value after depreciable life)/N(number of year of depreciable life)

Declining balance depreciation

applies a constant depreciation rate to the propertys declining book value

double declining balance(DBB)

depreciation is used in longer life assets at a rate of 150% or most commonly 200% of the straight-line rate

(DBB) dt =

2/N (book Value_t-1)

dt =

2/N * ( B - sum of dj from 1 to t-1) dt = deprecation charge in year t, B = costs of asset made ready to use, N - number of years of depreciable life

Bonus deprecation began in 2001

allows for immediate expensing of some or all of asset's cost( as high as 100%, attracive to businesses, partial in most years, if partial remaining book value depreciated by other methods)

Depreciation is part of determining corporate income taxes

what can be depreciated, how fast, all linked to a firms after-tax profits and comptetiveness

deprecation rules and regulations can be crafted to impact on total revenue received, to increase capital investment, and improve employment rates

In 1981 and 1986, the tax code was changed to allow depreciation over shorter periods and to give capital investments full depreciation, 2002 tax code was changed by the Job Creation and worker assistance act to allow additional first years depreciation, in 2009 America recovery and reinvestment act provided incentives to stimulate the economy.

pre 1981 classic methods

Straight line(SL)

sum of the years digits (SOYD)

Required estimates of useful life and salvage value

1981-1986 Accelerated cost recovery system (ACRS)

Property class lives were created

salvage value was ignored

shorter recovery periods were used

1986-present: Modified ACRS (MACRS)

more property classes

half year convention for first and final years

MACRS allows

the capitalized cost of an asset to be recovered over a specified period via annual deduction

Capitalized cost

Expense added to the cost basis of an asset

not expensed in the period the were incued in, but recognized over a period of time via depreciation or amortization

Straight line depreciation is used around the world

True

Accelerated methods are used around the world

True

Straight line depreciation is used to report annual financial results

True

Most countries allow accelerated methods for determining taxes

True

Straight Line(SL) dt =

(B-S)/N

Sum of the years digits(SOYD) dt =

((N- t +1)/SOYD)*(B-S)

Double declining balance dt =

2/N * (B-sum of dj)

Dt

depreciation charge in year t

B

cost of the asset made ready for use

S

Estimated salvage value after depreciable life

N

Number of years in depreciable life

SOYD

sum of years digists = N(N+1)/2

Tax Cuts and Jobs Act

Approved december 2017, expanded bonus depreciation

100% bonus depreciation, 2018-2022

Planned phase out(2023:80%, 2024:60%, 2025:40%, 2026: 20%, 2027: 0%)

Expanded section 179 deduction for small businesses(Complete expensing of up to 1 million in year of purchase)

Depreciation for taxes-MACRS

General depreciation system

base is declining balance

switches to straight-line

uses property class lives to detremine recovery period

salvage values assumed 0$

tables of anual % simplify calculations

Procedures in applying MACRS depreciation

Determine assets cost basis(B)

Determine property class and recovery period

determine assets cost basis

cost to obtain and place asset in service

may include fees and charges

Determine prpoerty class and recovery period

property class givne in problem

asset named in table 11-1 or IRS tables

Recovery period for that class

7-year for all other property not assigned

3 year property

Special handling devices for food beverage and manufacture

special tools for the manufacture of finisehd plastic products, fabricated metal products, motor vehicles

property with ADR class life of 4 years

5 year properties

automobiles and trucks(limited to 3560 first year, 5700 second year, 3560 third year, 2075 per year after)

aircraft(non air transport companies)

Equipment used in research and experimentation

Computers

petroleum drilling equipment

Property with ADR class life of more than 4 years and less then 10 years

7 year proprerties

all other property not assigned to another class

office furniture, fixtures, and equipment

property with ADR class life of 10 years or more and less than 16 years

10 year property

assets used in petroleum refining and certain food products

vessels and water transportation equipment

property with ADR class life of 16 years or more and less than 20 yeasr

15 yeas property

telphon distrubution plantss

municipal sewage treatment plants

property with ADR class life of 20 yeasr or more and less than 25 years

20 year property

municipal sewers

property with ADR class life of 25 years or more

27.5 year property

residential rental property(does not include hotels)

39 years

nonresidential real property

Personal property(all property not real estate)

3, 5, 7, 10, 15, and 20 year property classes

Real property(real estate)

27.5 and 39 year property classes

Applying MACRS dt =

B * rt

dt = depreciation deduction in year t

B = cost basis being depreciated

rt = appropriate MACRS percentage rate

Calculating MACRS GDS percentages

Declining balance start

3,5,7,10 year classes use 200%

15-20 year classes use 150% declining balance depreciation

Convert to straight line depreciation in optimal year, when SL provides higher annual depreciation

half year depreciation for first and last year

salvage value assumed = 0

Unit of production depreciation

when depreciation related to use more than time

UOP depreciation =

production for year/(total lifetime production) * (B-S)

Depletion

exhaustion of natural resources by removal

depletion allowance is larger of the two methods

cost delpletion( similar to unit of production depreciatio, permissible for standing timber and most oil and gas wells, cost of land must be excluded)

Percentage depletion(% of propertys gross income during year, cannot exceed 50% of propertys taxable income without depletion deduction)

Sulfer, uranium, and if from deposits in US, asbestos, lead ore, zinc ore, nickel ore, mica

22%

Gold, silver, copper, iron ore, certain oil shale if from US deposits

15%

Borax, granite, limestone, marble, mollusk shells, potash, slate, soapstone, and carbon doixide produced from a well

14%

Coal, lignite, sodium chloride

10%

Clay & shale used or sold for use in making sewer pipe or bricks or used or sold for use as sintered or burned lightweight aggregates

7 1/2%

Clay used or sold for making drainage and roofing tile, flower pots and kindred products and gravel sand stone other ston used or sold for use by a mine owner or operator as dimension or ornamental stone

5%

Straightline Excel

SLN(cost, salvage, life)

Double declining balance excel

DBB(cost, salvage, life, period, [factor])

Sum of years digits excel

SYD(cost, salvage, life, period)

Variable declining balance excel

VDB(cost, salvage, life, start_period, end_period, [factor], [no_switch])