Depreciation

16.
1 Depreciation Methods for

Financial Statement Reporting
 Depreciate an asset and prepare a

depreciation schedule
 using the straight-line method
 using the units-of-production method
 using the sum of the years’ – digits
method
 Using the declining balance method
Business Math, Eighth Edition © 2009 Pearson Education, Inc. Upper Saddle River, NJ
Cleaves/Hobbs 07458 All Rights Reserved
Key Terms
 Assets: properties owned by the business,
including anything of monetary value and
anything that can be exchanged for cash or
other property.
 Estimated life or useful life: the number of
years an asset is expected to be useable.
 Salvage value, scrap value, or residual value:
an estimated dollar value of an asset at the end
of the asset’s estimated life.
Key Terms
 Depreciation: the amount an asset decreases in value
from its original cost.
 Straight-line depreciation: a method of depreciation

in which the amount of depreciation of an asset is
spread equally over the number of years of useful life of
the asset.
 Total cost: the cost of an asset including shipping and

installation charges.
 Depreciable value: the cost of an asset minus the

salvage value.
16.1.1. Use the Straight Line
Depreciation Method
 Find the total cost of the asset

TC = cost + shipping + installation
 Find the depreciable value

Depreciable value = TC – salvage value
 Find the yearly depreciation:

= depreciable value ÷ years of expected life
Look at this example
 Use the straight-line method to find the yearly
depreciation for a plating machine that has an
expected useful life of 5 years. The plating
machine cost $27,300; its shipping costs totaled
$250, installation charges came to $450 and its
salvage value is $1,000.
 TC= $27,300 + $250 + $450 = $28,000

 Depreciable value = $28,000 - $1,000 = $27,000
 Yearly depreciation = $27,000 ÷ 5 = $5,400
Try this example
 A labeling machine cost $43,000.
Installation costs totaled $1,250 and
shipping costs totaled $2,250. It has an
expected useful life of 10 years. Its salvage
value is $2,000. Use the straight-line
method of depreciation to find the yearly
depreciation for the labeling machine.
 The depreciation is $4,450 per year

Key Terms
 Depreciation schedule: a table showing the
year’s depreciation, the accumulated
depreciation, and the end-of-year book value.
 Accumulated depreciation: the current year’s
depreciation plus all previous years’
depreciation.
 End-of-year book value: total cost minus
depreciation for the first year. Thereafter, it is
the previous year’s end-of-year book value
minus the current year’s depreciation.
16.1.2 Units-of-Production Method
 Takes into account an asset’s use in terms of
production, for example:
 Items produced
 Miles driven
 Hours operated
 Number of times it has performed a specific operation
Companies that use this method internally

often adjust to a method acceptable by the
IRS for tax-reporting purposes
Find the unit depreciation
 Unit depreciation =
Depreciable value
Units produced during expected life
 Depreciation for units produced

= unit depreciation x units produced
 A label making machine that costs $28,000
after shipping and installation is expected to
print 50,000,000 labels during its useful life.
If the salvage value of the machine is
$1,000, find the unit depreciation and the
depreciation for printing 2,125,000 labels.
(go to next slide)
Find the depreciation
 Unit depreciation = depreciable value ÷ units
produced during expected life
 Unit production = $27,000/ 50,000,000
 Unit depreciation = $0.00054
 Depreciation for 2,125,000 labels
= $0.00054 x 2,125,000 = $1,147.50
 The depreciation for that number of labels is
$1,147.50.
Try this example
A small pickup truck was purchased for
occasional deliveries during the busy season of
Eager Enterprises. Total cost of the truck was
$24,000. The salvage value is $2,500. The
expected number of miles to be driven over the
truck’s useful life is 100,000. Find the
depreciation after one year is the truck has
been driven 3,000 miles.
 $645 is the depreciation amount
16.1.3 Sum-of-theYears’
Digits Method
 Sum-of-the-years’ digit method: A

depreciation method which allow the greatest
depreciation the first year and decreasing
amount each year thereafter.
 Year’s depreciation rate: the depreciation rate
for any given year of a depreciation schedule.
Find the year’s depreciation
 The numerator of the year’s depreciation rate is
the number of years of expected life remaining.
 The denominator of the year’s depreciation rate

is the sum of the numbers from 1 to the years of
expected life.
 Shortcut for finding the sum:

n(n+1) = sum
2
 Find the depreciation for each of the five years
of expected life of a bottle capping machine that
costs $27,300 and has a shipping cost of $250
and an installation cost of $450, and a salvage
value of $1,000. Make a depreciation schedule.
 Denominator = 5 (6) ÷ 2 = 15
 Numerator for year 1 = 5; year 2 = 4 and so on.
 Depreciable value = TC – salvage value
 Depreciable value = $27,000
Depreciation schedule
 Year 1 = $27,000 x 5/15 = $9,000
End of year book value = $28,000-$9,000=$19,000
 Year 2 = $27,000 x 4/15 = $7,200
End of year book value = TC – accumulated
depreciation = $11,800
 Now, calculate the depreciation and book value for
Years 3, 4, 5.
 Y 3 $5,400 and end-of year book value is $6,400.
Y 4 $3,600 and end-of year book value is $2,800.
Y 5 $1,800 and end-of year book value is $1,000.
16.1.4 Declining Balance
Method of Depreciation
 A depreciation method that provides for large
depreciation in the early years of the life of an
asset.
 Double-declining rate (or 200% declining-
balance method): a declining balance
depreciation that is twice the straight-line
depreciation.
 150% declining rate: a common declining
balance rate that is 1 ½ times the straight line
rate.
Find the depreciation
 Yearly double declining rate = yearly straight
line depreciation rate x 2
 Yearly 150% declining depreciation rate =
yearly straight line depreciation rate x 1.5
 First year’s depreciation = total cost x yearly
depreciation rate
 For all other years: Year’s depreciation =
previous end-of-year book value x yearly
depreciation rate.
 An ice-cream freezer has a useful life of six
years. Find the yearly:
 straight line rate expressed as a decimal and
a percent
 Double-declining rate expressed as a
decimal and a percent.
 150%-declining rate expressed as a decimal
and a percent.
The rates
 Straight-line = 1/6 or .1667 or

16.67%
 Double-declining = 2(1/6) = 1/3 or 33%
 150% declining rate = 1.5 (1/6) = 0.25 or 25%
Tip!
 In declining-balance depreciation, the
depreciation for the first year is based on the
total cost of the asset.
 Do not subtract the salvage value from the total
cost to find the depreciation in the first year.
 The end-of-year book value for any year cannot
drop below the salvage value of the asset. If the
depreciation would cause it to drop below the
salvage value, the year’s ending value will be
the salvage value.
 A packaging machine costing $28,000 with an
expected life of five years and a resale value of
$1,000 is depreciated by the declining balance
method at twice the straight-line rate. Prepare
a depreciation schedule.
 Year one (2) x 1/5 = 2/5 or 40% or .40
 $28,000 x 40% = $11,200
 End of year 1 book value = TC – depreciation
 End of year 1 = $28,000- $11,200 = $16,800
Finish the depreciation schedule
 Year Two = previous end-of-year book

value x double-declining rate
$16,800 x 0.4 = $6,720
 End-of-year Two book value =

previous end-of-year book value –
depreciation = $16,800 - $6,720 = $10,080
(go to next slide)
Years 3, 4 and 5
 Year Three =
previous end-of-year book value x double-
declining rate = $10,080 x 0.4 = $4,032
 End-of- year Three book value
= $10,080 - $4,032 = $6,048
 Year Four depreciation = $2,419.20
End of year Four book value = $3,628.80
 Year Five depreciation = $1,451.52
End-of-year Five book value = $2,177.28
16.2 Depreciation
Methods for IRS Reporting
 Depreciate an asset and prepare a

depreciation schedule using the modified
accelerated cost-recovery system (MACRS)
 Depreciate an asset after taking a section

179
16.2.1 Using MACRS
 In, 1981, the IRS enacted an accelerated cost-
recovery system (ACRS) for the depreciation of
property put into service after that date.
 Allowed businesses to write off cost of assets

more quickly.
 Objective was to encourage businesses to

invest in more assets despite an economic
slowdown at the time.
Table 16-5
 Table 16-5 indicates that each recovery period
has a depreciation rate for one year more than
the recovery period indicates.
 First and last year in the recovery period are

partial years.
 Greatest amount of depreciation is realized in

the second year, which is the first full year.
Using the MACRS Method
 Using the IRS publication, determine the
asset’s recovery period and find the
appropriate table.
 Find the MACRS rate using Table 16-5
 Multiply the year’s MACRS rate by the total
cost of the asset.
 Year’s Depreciation =
Year’s MACRS rate x total cost
Why is this easier than traditional
depreciation methods?
1. You do not have to find a depreciable value.
2. You do not have to determine a salvage

value.
3. The useful life is determined by the property

classes.
Find the depreciation for each year for a boiler
that was purchased for $28,000 and placed in
service at midyear under the MACRS method of
depreciation as a five-year property.
 Year 1 depreciation = MACRS rate x Total Cost
 Year 1 depreciation = 20% x $28,000
 Year 1 depreciation = $5,600
 Do the subsequent years through Year 6.
 Check calculations on the following slide.
Check your calculations.

 Year 4 depreciation = $3,225.60
 The sum of yearly depreciations equals the total
cost of the asset ($28,000).
16.2.2 Depreciate an Asset After
Taking a Section 179 Deduction
 For tax purposes, it can be treated as a one-time
expense, rather than as a capital expenditure that
is depreciated over several years.
 The amount that is claimed under Section 179 is
subtracted from the original price of the property
and the balance can be depreciated using any of
the approved methods of depreciation.
 Eligible only in the first year that a qualifying
property is purchased and placed into service.
Section 179 Deduction
 Property must be placed in service for
business purposes only. A property put in
service first for personal use and subsequently
for business use would not be eligible.
 Eligible property, in general, is tangible,
depreciable personal property that is used for
the production of income.
 Can only be used to reduce taxable income, not
to create a net loss; estates and trusts cannot
claim the Section 179 deduction.
How to depreciate an asset after
taking a Section 179 deduction
 Decide how much of the maximum section 179

allowance to apply to the asset.
 Subtract the elected section 179 deduction from
the total cost of the asset.
 Apply an approved depreciation method to the
value from the previous step, instead of the
actual total cost.
 Find the first year depreciation using MACRS
for the 7th Inning’s kitchen, that is purchased
and placed into service at midyear. The price of
the property is $125,250 and the maximum
$100,000 section 179 deduction is elected.
 $125,250-$100,000 = $25,250
 $25,250 x 14.29% (MACRS rate) = $3,608.23
 The first year’s depreciation is $3,608.2336

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16.

1 Depreciation Methods for

 Depreciate an asset and prepare a

 Straight-line depreciation: a method of depreciation

 Total cost: the cost of an asset including shipping and

 Depreciable value: the cost of an asset minus the

 Find the total cost of the asset

 Find the depreciable value

 Find the yearly depreciation:

 TC= $27,300 + $250 + $450 = $28,000

 The depreciation is $4,450 per year

Companies that use this method internally

 Depreciation for units produced

(go to next slide)

 $645 is the depreciation amount

 Sum-of-the-years’ digit method: A

 The denominator of the year’s depreciation rate

 Shortcut for finding the sum:

 Straight-line = 1/6 or .1667 or

 Double-declining = 2(1/6) = 1/3 or 33%

 150% declining rate = 1.5 (1/6) = 0.25 or 25%

 Year Two = previous end-of-year book

 End-of-year Two book value =

(go to next slide)

 Depreciate an asset and prepare a

 Depreciate an asset after taking a section

 Allowed businesses to write off cost of assets

 Objective was to encourage businesses to

 First and last year in the recovery period are

 Greatest amount of depreciation is realized in

1. You do not have to find a depreciable value.

2. You do not have to determine a salvage

3. The useful life is determined by the property

 Year 2 depreciation = $8,960

 Decide how much of the maximum section 179

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