DEPRECIATION Chapter Fourteen

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

Depreciation – Asset Cost –

An estimate of the use or Amount paid for an asset including
deterioration of an asset freight charges

Estimated Useful Life –

Residual Value (Salvage Value) -
Number of years or time periods Expected cash value at the end of
for which the company can use an asset’s useful life.
the asset

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 CONCEPT OF DEPRECIATION

Accumulated Depreciation – The total amount of the asset’s depreciation taken to date.

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.

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 CAUSES OF DEPRECIATION

Product Obsolescence Physical Deterioration

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 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

Example:
Ajax Company bought equipment for $2,500. The company estimates that
the equipment’s period of useful life will be 5 years. After 5 years the
residual value is $500. Calculate depreciation expense and complete a
depreciation schedule.

($2,500 -- $500) = $400 100% = 100% = 20%

5 # of yrs. 5
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DEPRECIATION SCHEDULE

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 DEPRECIATION FOR PARTIAL YEARS

15th Rule: If a company buys an asset before the 15th of the 15th
month, the company calculates the asset’s depreciation for Rule
a full month.

Assume Ajax Company bought equipment on May 6. The cost is

$2,500 with an estimated useful life of 5 years. The residual
value is $500. What would be depreciation for the first year?

$2,500 -- $500 = $400 x 8 = $266.67

5 12
May, June, July,
Aug, Sept., Oct.,
Nov., & Dec.

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 UNITS-OF-PRODUCTION METHOD

Depreciation determined by how much the company uses the asset.

Depreciation expense = Cost -- Residual value = ($2,500 -- $500) = $.50

per unit Total estimated units produced 4000

Depreciation = Unit x Units

amount depreciation produced

Example:
Ajax Company (in Learning Unit 14–1) buys equipment ($2,500), 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. 14-8
DEPRECIATION SCHEDULE

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 DECLINING-BALANCE METHOD

Accelerated method which computes more depreciation expense in the early

years of the asset’s life. Uses up to twice the straight-line rate.

Rate = 100% x 2 = 40%

5 years

Depreciation expense = Book value of equipment x Depreciation

each year at beginning of year rate

Example:
Ajax Company (in Learning Unit 14–1) buys equipment ($2,500), 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.
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DEPRECIATION SCHEDULE

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 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.

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 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 14.5 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.

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MODIFIED ACCELERATED COST RECOVERY
SYSTEM (MACRS) (TABLE 14.4)

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 ANNUAL RECOVERY FOR MACRS
(TABLE 14.5)
Recovery 3-year class 5-year class 7-year class 10-year class 15-year class 20-year class
year (200% D.B.) (200% D.B.) (200% D.B.) (200% D.B.) (150% D.B.) (150% D.B.)

1 33.00 20.00 14.28 10.00 5.00 3.75

2 45.00 32.00 24.49 18.00 9.50 7.22
3 15.00 19.20 17.49 14.40 8.55 6.68
4 7.00 11.52 12.49 11.52 7.69 6.18
5 11.52 8.93 9.22 6.93 5.71
6 5.76 8.93 7.37 6.23 5.28
7 8.93 6.55 5.90 4.89
8 4.46 6.55 5.90 4.52
9 6.55 5.90 4.46
10 6.55 5.90 4.46
11 3.29 5.90 4.46
12 5.90 4.46
13 5.90 4.46
14 5.90 4.46
15 5.90 4.46
16 3.00 4.46
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DEPRECIATION SCHEDULE

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