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MER 439 - Design of Thermal Fluid Systems Engineering Economics Depreciation Methods Professor Anderson Spring Term 2012

MER 439 - Design of Thermal Fluid Systems Engineering Economics Depreciation Methods Professor Anderson Spring Term 2012. Definitions of Depreciation. Definitions : decrease in value, amortized cost, difference in value between an existing old asset, impaired serviceableness

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MER 439 - Design of Thermal Fluid Systems Engineering Economics Depreciation Methods Professor Anderson Spring Term 2012

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  1. MER 439 - Design of Thermal Fluid Systems Engineering EconomicsDepreciation Methods Professor Anderson Spring Term 2012

  2. Definitions of Depreciation • Definitions: decrease in value, amortized cost, difference in value between an existing old asset, impaired serviceableness • Accounting Definition: Reduction in the value of an asset with time,“Book Depreciation” vs “Tax Depreciation” • Concepts of Value: Market Value vs Value to owner

  3. Depreciation Terminology Depreciation: reduction in the value of an asset using (government) approved rules Dt: depreciation amount B: first cost (installed cost of asset) (Also called the “Unadjusted Basis” or simply “Basis” … hence the “B”) BVt: book value - represents the remaining un-depreciated investment (value) on the books. Determined at the end of the year Note the “t” subscript refers to “time” in years

  4. Depreciation Terminology n: recovery period (depreciable life of asset in years) dt: depreciation rate (fraction of first cost removed by depreciation in a given year). SV: salvage value (estimated market value at the end of an asset’s useful life).

  5. Depreciation Terminology Depreciation is allowed for personal or real property. Methods: (1) Accelerated methods (2) Uniform Methods (3) Decelerated Methods CHOICE IS INFLUENCED BY TAX LAWS

  6. Straight Line Depreciation

  7. SL Depreciation Example Consider a machine tool with a first cost of $35,000 an estimated life of 20 years and an estimated salvage value of $3,500. Use SL depreciation and calculate the depreciation charge and the book value of the machine tool after 4 years.

  8. Declining Balance Depreciation Assets are commonly worth more in initial years – it is sensible to write off costs more rapidly in the early years. Declining Balance: a given depreciation rate (d) is applied to the remaining book value each year. i.e. 10% applied to a $35,000 asset 1st year Dt = 0.01*(35000) = 3500 2nd year Dt = 0.10*(35000-3500) = 3150

  9. Declining Balance Depreciation The maximum allowable percentage is double the straight line rate: (also called Double Declining Balance or DDB method) dmax = 2/n The actual depreciation rate is: dt = d*(1-d)t-1 Dt = d*BVt-1 Dt = d*B*(1-d)t-1 BVt = B*(1-d)t

  10. DB Depreciation Example Assume that an asset has a first cost of $25,000 and an estimated salvage value of $4000 after 12 years, Calculate its depreciation and book value for (a) year one and (b) year four using the DDB method.

  11. MACRS Economic Reform Act (1981) – ACRS Tax Reform Act (1986) - MACRS • Applies to property placed in service after 12/31/86 • Doesn’t use useful life or SV • Property is organized into ASSET Classes and assigned a Class Life.

  12. MACRS Dt = dt*B (dt is set by the government) BVt = BVt-1-Dt The first cost is always completely depreciated – assumes SV = 0

  13. MACRS Rates - Half Year Convention

  14. MACRS Depreciation Example Calculate the depreciation charge and book value for an asset worth $100,000 using MACRS depreciation with a three year recovery period.

  15. MACRS Recovery Period Set by the government…http://www.irs.gov/publications/p946/ch04.html

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