1. Accounting for Depreciation Park 9

2. Depreciation • Depreciation is the loss of value of fixed assets over time. • Depreciation accounting is to account for the cost of fixed assets in a pattern that matches their decline in value over time. • The process of depreciating an asset requires that we know some things: • What is the cost of the asset? • What is the depreciable life of the asset? • What is the asset’s value at the end of its useful life? • What method of depreciation do we choose?

3. Depreciable Property • A depreciable asset is property for which a firm may take depreciation deductions against income. • U.S tax law requires the depreciable property must: • Be used in business or held for the production of income • Have a definite service life, which must be longer than 1 year • Be something that wears out, decays, gets used up, becomes obsolete, or loses value from natural causes

4. Depreciable Property • Depreciable property includes buildings, machinery, equipment, vehicles, and some intangible properties • Inventories are not depreciable property because they are held primarily for sale to customers in ordinary course of business. • If an asset has no definite service life, it cannot be depreciated. • Land can never be depreciated, but any land improvements have a limited useful life, so they are subject to depreciation

5. Cost Basis • The cost basis represents the total cost that is claimed as an expense over the asset’s life • Total cost, rather than the cost of the asset only, must be the basis for depreciation charged as an expense over an asset’s life.

6. Useful Life and Salvage Value • Asset depreciation ranges (ADRs) are guidelines that specify a range of lives for classes of assets, based on historical data, allowing taxpayers to choose a depreciable life of a given asset. • Salvage value is the estimated value of an asset at the end of its useful life; the amount eventually recovered through sale, trade-in, or salvage.

7. Book Depreciation • Book depreciation is depreciation calculated for financial reports, such as a balance sheets or income statements. • It enables firms to report depreciation to stockholders, where actual loss in the value of the asset is reflected.

8. Book Depreciation Methods • Three different methods can be used to calculate the periodic depreciation allowances for financial reporting: • Straight-line (SL) method • Declining-balance (DB) method • Unit-of-production method

9. Straight-Line Method (SL) • The straight-line method of depreciation interprets a fixed asset as an asset that provides its service in a uniform fashion. • Depreciation rate is 1/N, where N is the depreciable life. • Dn = (1/N) * (I – S) • Excel: =SLN(cost, salvage, life)

10. Declining-Balance Method (DB) • The declining-balance method recognizes that the stream of services provided by a fixed asset may decrease over the asset’s service life • α = (1/N) (multiplier) • Dn = α * (Bn of previous year) • Most common multipliers used in the U.S. are 1.5 (called 150% DB) and 2.0 (called 200% DDB, or double-declining-balance)