Depreciation

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Methods of calculating depreciation

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Depreciation

  1. 1. (c) 2001 Contemporary Engineering Economics 1
  2. 2. PRESENTED BY: Javeria 11-arid-3303 MIT-3University Institute of Information Technology, Rawalpindi(UIIT,UAAR) Pakistan
  3. 3. Depreciation is the reduction in value of anasset over time due to:  wear and tear  effluxion of time  obsolescence
  4. 4. What Can Be Depreciated?A qualifying asset for depreciation must satisfy all theseconditions:  should be used in business  should have a definite useful life and a life longer than 1 year  must wear out, become obsolete or lose value
  5. 5. Types of DepreciationBook DepreciationTax Depreciation
  6. 6. Methods to Calculate Depreciation Straight-Line Method Declining Balance Method MACRS Method
  7. 7. Required Factors in Calculating Asset Depreciation Useful life of asset Residual value Cost basis Method of depreciation
  8. 8. 1. Straight-Line (SL) MethodPrinciple A fixed asset provides its service in a uniform fashion over its lifeFormula Annual Depreciation = cost – residual value useful life
  9. 9. EXAMPLE (Straight-Line Method)Cost of machinery = $45,000Residual value = $5,000Useful life = 5 years.Calculate annual cost of depreciation? Year Computation Depreciation Accumulated Book Value Expense Depreciation $45,000 First (45,000-5,000)/5 $8,000 $8,000 37,000 Second (45,000-5,000)/5 8,000 16,000 29,000 Third (45,000-5,000)/5 8,000 24,000 21,000 Fourth (45,000-5,000)/5 8,000 32,000 13,000 Fifth (45,000-5,000)/5 8,000 40,000 5,000 Total 40,000
  10. 10. Example - (Straight-Line Method)AnnualDepreciationexpense 1 2 3 4 5 Years
  11. 11. 2. Declining Balance MethodPrinciple A fixed asset provides its service in a decreasing fashion. The book value is reduced by a fixed percentage each year.Formula Annual Depreciation = Depreciation rate * Book value at start of year Depreciation rate 200% Declining Method: Depreciation rate = 2/useful life 150% Declining Method : Depreciation rate = 1.5/useful life 130% Declining Method: Depreciation rate = 1.3/useful life
  12. 12. EXAMPLE (200% Declining Balance Method)Cost of machinery = $70,000Residual value = $5000Useful life = 5 yearsCost of annual Depreciation?Year Computation Depreciation Accumulated Book Value Expense Depreciation $70,000First $70,000 x 40% $28,000 $28,000 42,000Second 42,000 x 40% 16,800 44,800 25,200Third 25,200 x 40% 10,080 54,880 15,120Fourth 15,120 x 40% 6,048 60,928 9,072Fifth 9,072-$5,000 4,072 65,000 5,000Total 65,000
  13. 13. Example – 200% Declining Balance MethodAnnualDepreciationexpense 1 2 3 4 5 Years
  14. 14. 3. MACRS MethodPrincipleAn asset has a fixed life according to the category inwhich it falls.The residual value is always zero.Formula Annual Depreciation = cost x appropriate MACRS % rate
  15. 15. TABLE OF PROPERTY CLASS AND NUMBER OF YEARS Years (c) 2001 Contemporary Engineering Economics 15
  16. 16. (c) 2001 Contemporary Engineering Economics 16
  17. 17. EXAMPLE (MACRS Method)Cost of tractor = Rs. 30,000Cost of annual Depreciation?Year Computation Depreciation Accumulated Book Value Expense Depreciation $30,000First 33.33% x 30,000 9,999 9,999 20,001Second 44.45% x 30,000 13,335 23,334 6,666Third 14.81% x 30,000 4,443 27,777 2,223Fourth 7.41% x 30,000 2,223 30,000 0

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