CTC 475 Review

 Cost Estimates
CTC 475
Depreciation
 Objectives
 Know the historical (SL, DB, SYD) and
MACRS methods to determine book values
and depreciation
 Tax Concepts
 Taxes affect cash flows
 Depreciation affects taxes
 Depreciation method is determined by
law:
 Post ’86-MACRS (Modified Accelerated Cost Recovery System)
 ’81-’86 ACRS (Accelerated Cost Recovery System)
 Pre ’81-other methods (SL, DB, SYD)
 SL-straight line; DB-declining balance; SYD-
sum of the year’s digits
 Depreciable Property
3 Requirements
1. Must be used in business or held for the
production of income

2. Life can be determined and is longer

than one year

3. Must be something that wears out,

decays, gets used up, becomes obsolete,
or loses value from natural causes
 Depreciable Property
 Tangible (machines, cars, computers)
 Intangible (copyrights, franchises)
 Real (erected on land, growing on land,
attached to land; however, land itself is
not depreciable)
 Personal (machines, cars)
 Most depreciable property is tangible,
personal
 Adjusted Cost Basis
 Cost of property +
 Cost of additions +
 Installation cost
 Book Value
 The worth of a depreciable property as
shown on the accounting records
 Recovery Period
 Time over which cost basis can be recovered
 sets as
 3,5,7,10,15, or 20 (for tangible property)
 27.5 (for residential real property)

 31.5/39 years (for nonresidential real property)

Refer to Table 12.2 (MACRS depletion rates) and Table

12.4 (Example recover periods)
 The recovery period is usually shorter than the
actual physical life
 Examples
 3-year property
 Tractor units, special tools, race horses
 5-year property
 Autos, buses, computers, office machinery
 7-year
 Office furniture, theme/amusement park assets
 10-year property
 Vessels, tugs, assets used in petroleum refining
 15-year property
 Sewage treatment plants, sidewalks, roads, drainage facilities
bridges, fencing, landscaping, transmission lines
 20-year property
 Farm buildings
 Depreciation Methods
 SL-straight line
 DB-declining balance
 SYD-Sum of the years digits
 MACRS, modified accelerated cost
recovery system
Depreciation Methods-Example
 7-year property
 Basis is $100K
 SV=0
 SL Example
 Depreciation is 1/7 (14.28%) * Cost Basis
 14.28% * $100K = $14,286
Straight Line Method
EOY Depreciation Book Value
0 - $100K
1 $14,286 $85,714
2 $14,286 $71,428
3 $14,286 $57,142
4 $14,286 $42,856
5 $14,286 $28,570
6 $14,286 $14,285
7 $14,285 0
What’s Wrong with this Method?
 DB Example
 Cost Basis is $100K
 Depreciable Life is 7 years
 200% DB----
 Depreciation is 2/7 (28.56%) * Book Value of
previous year
 150% DB----(not used for this example)
 Depreciation would be 1.5/7 * Book Value of
previous year
 Declining Balance Method
EOY Depreciation Book Value
0 - $100K
1 28.56%*$100K=$28,560 $71,440
2 28.56%*$71,440=$20,403 $51,036
3 28.56%*$51,036=$20,403 $36,460
4 28.56%*$36,460=$10,413 $26,047
5 28.56%*$26,047=$7,439 $18,608
6 28.56%*$18,608=$5,314 $13,294
7 28.56%*$13,294=$3,797 $9,497
What’s Wrong with this Method?
 SYD Example
 Cost Basis is $100K
 Depreciable Life is 7 years
 Number the depreciable life years in
reverse order
 Sum up the numbers
 Year/Sum=Depreciation Amount applied
to cost basis
 SYD Method
Year Reverse Order Depreciation Rate
1 7 7/28=25%
2 6 6/28=21.4%
3 5 5/28=17.8%
4 4 4/28=14.3%
5 3 3/28=10.7%
6 2 2/28=7.1%
7 1 1/28=3.5%
Sum=28 Sum=100%
 SYD Method
EOY Depreciation Book Value
0 - $100K
1 $25,000 $75,000
2 $21,428 $53,572
3 $17,857 $35,715
4 $14,286 $21,429
5 $10,714 $10,715
6 $7,143 $3,572
7 $3,572 0
 MACRS
 3,5,7,10 yr (200% DBSLH)
 15, 20 yr (150% DBSLH)
 DBSLH (Declining Balance switching to
Straight-Line depreciation at the optimum time
with a Half-year convention)
 See table 12.2 for depreciation rates which are
multiplied by the cost basis
 Note that the half-year convention extends
depreciation rate one year beyond the
recovery period (ex 4 vs 3 year)
 MACRS Method
EOY Depreciation Book Value
0 - $100K
1 14.29%*$100K=$14,290 $85,710
2 24.49%*$100k=$24,490 $61,220
3 17.49%*$100K=$17,490 $43,730
4 12.49%*$100K=$12,490 $31,230
5 8.93%*$100K=$8,930 $22,310
6 8.92%*$100K=$8,920 $13,390
7 8.93%*$100K=$8,930 $4,460
8 4.46%*$100K=$4,460 $0
 Depreciation Methods
Straight Line Method
$100,000
Declining Balance
Book Value

$80,000 Sum of Years

$60,000 DB switch to SL
$40,000
$20,000
$0
0 1 2 3 4 5 6 7 8 9
EOY
 Next lecture
 Taxes

 ATCF’s taking into account

depreciation