Professional Documents
Culture Documents
Depreciation Models
Depreciation Definition
Depreciation is the reduction of an assets value over time.
Brought on by:
Wear and tear, Use, Deterioration, Obsolescence
Personal Property
Personal property is the income-producing, tangible
possessions of a corporation used to conduct business.
Not to be confused with an individuals personal property like
clothes, furniture, etc.
Included are:
most manufacturing and service industry property vehicles,
manufacturing equipment, materials handling devices,
computers, and networking equipment, telephone equipment
office furniture, refining process equipment, and much more.
Real Property
Real property includes real estate and all improvements
office buildings manufacturing structures, warehouses,
apartments, and other structures.
Importance of Depreciation
Taxes law defines the concept of taxable income as:
Gross Income Real Cash Expenses interest Depreciation amounts
Depreciable?
Property is depreciable if it must:
be used in business or held to produce income
have a determinable useful life which is longer than
one year
wear out, decay, get used up, become obsolete, or lose
value from natural causes
not be inventory, stock in trade, or investment
property
Types of Depreciation
Book Depreciation
Value of the asset on the firms accounting records at any
given point in time.
Used for internal managerial decision making.
Management is free to use any method they so choose to
compute book depreciation amounts
Tax Depreciation
Used by a firm for state and federal income tax reporting
Follows strict rules and regulations.
Depreciation Terms
The Basis (B) of an asset is:
Purchase cost plus,
Delivery costs plus,
Installation costs and,
Any other costs associated with installing and preparing the asset for use.
Market Value
Market Value (MVt)
Market value is the estimated amount realizable if the asset were
sold on the open market.
Because of the structure of depreciation laws, the book value and
market value may substantially differ.
For example, a commercial building tends to increase in market
value, but the book value will decrease as depreciation charges are
taken
Salvage Value
Salvage Value (SV) is the estimated trade-in or market
value at the end of the asset's useful life
Expressed as an estimated dollar amount or as a percentage
of the first cost
Salvage values are estimated up-front at the time of the
original purchase.
Generally speaking, one cannot depreciate an asset below its
estimated salvage value.
Recovery Period-n
Recovery Period (in years) is the depreciable life n of the asset
in years.
Recovery Period -- Number of years over which basis of
property is recovered through accounting process.
Normally the useful life for classical methods
Depreciation Models
Basic (traditional) models are:
Straight-Line Method (SL),
Sum-of-the-Years Digits Method (SYD),
Declining Balance Method (DB).
Dt ( B S ) d
Dt
BS
n
Provides greater depreciation amounts in the early time periods over the SL
method.
Requires assuming a DB rate normally taken to equal 2 x SL rate.
Given the DB rate,
Dt for year t is found by multiplying the beginning of time period book value by
the rate.
DB Equations
Dt ( d ) BVt 1
[16.5]
dt ( d ) B(1 d )t 1
DB if BVt-1 Not Known
Dt ( d ) B (1 d ) t 1
BVt B(1 d )t
BVt BVt 1 D
[16.7]
[16.8]
[16.9]
[16.6]
Implied d = 1 (S/B)1/n
[16.11]
Property Classes
27-Year Property: (Real Property)
Residential rental property (homes and mobile homes).
39-Year Property (Real Property)
Nonresidential real property attached to the land, but NOT
the land itself.
5-Year Property:
Computers and peripherals, Duplicating equipment, Automobiles, trucks,
buses, Cargo containers, Some manufacturing equipment.