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Depreciation. Chapter 4. Depreciation. Allocating the expense of a resource which lasts > 1 year. e.g. tractors, barns, bulls, fences. Calculation Need to know: 1. Purchase Price – Cost 2. Useful Life – Life 3. Salvage Value – S.V. 4. Depreciation Method – Meth .
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Depreciation Chapter 4
Depreciation • Allocating the expense of a resource which lasts > 1 year. • e.g. tractors, barns, bulls, fences. • Calculation • Need to know: • 1. Purchase Price – Cost • 2. Useful Life – Life • 3. Salvage Value – S.V. • 4. Depreciation Method – Meth
Depreciation Methods: Straight Line • Annual Depreciation = (cost-salvage value) /useful life Or • Annual Depreciation = (cost–salvage value)*R • Where R is the annual straight- line percentage rate found by dividing 100% by the useful life (100% / useful life)
Depreciation Methods: Sum of the Year’s Digits (SOYD) • Annual Depreciation = (cost-salvage value) * RL/ SOYD Where • RL= remaining years of useful life as of the beginning of the year for which depreciation is being computed. • SOYD= sum of all the number from 1 through the estimated useful life. For example for a 5-year useful life, SOYD would be 1+2+3+4+5=15 and it would be 55 for a 10 year useful life. • Highest the first year and then declines by a constant amount after.
Depreciation Method: Declining Balance • Annual Depreciation is = (Book Value at Beginning of Year) * R Where • R is a constant percentage value or rate. • A variation on this is double declining balance. • Can’t have a zero salvage value.
Depreciation Method: Partial Year Depreciation • For an asset purchase during the year the depreciation should be prorated for the amount of time that asset was used during the year.
Income Tax Depreciation • Current system is called MACRS • Assumptions: • An implied salvage value of zero • One-half year of depreciation allowed in the year of purchase regardless of the purchase date (some exceptions) • A system of property classes which fixes the useful life for each type of property.
Income Tax Depreciation • 3-,5-,7-,10-,15-, or 20- year classes Examples • 3-year: breeding hogs • 5-year: cars, pickups, breeding cattle and sheep, dairy cattle, computers, trucks. • 7-year: most farm machinery and equipment, fences, grain bins, silos, office furniture • 10-year: Single purpose agricultural and horticulture structures such as confinement swine facilities and green houses as well as trees bearing fruits or nuts. • 15-year: water wells, paved lots, drainage tile. • 20-year: general-purpose buildings such as machine sheds and hay barns
Income Tax Depreciation • Rates are now based on the 150% declining balance method. • An example for a 5-year class of property 15% 25.5% 17.85% 16.66% 16.66% 8.33% • Notice it’s 6 years. Get only a half year the first year and a half the last.
Valuation of Assets • It is necessary to determine the value of assets • Tax-purpose • Profit/ Income purposes
1. Market Value • Current market price • “Fair Market Value” • Could or will be sold in short period of time • Ex: Stocks, bonds, cattle, hay, grain
2. Cost • Valued at their original cost • This method works well for items that have to be purchased frequently. • eg. Supplies, feed, fertilizer • Items that lose value over time should not be valued with this method
3. Lower of Cost or Market • Value it at both and take the lower. • Minimizes change of placing too high a value on any item. Truck Price increases > $12,000 (inflation) Cost $12,000 Anything lower is market value.
4. Farm Production Cost • Items produced on farm can be valued at their production costs. • ie. Corn used for feeding. No opportunity costs *Conservative Valuation.
5. Cost Less Depreciation • Original cost less depreciation • Machinery, buildings, fences, breeding livestock • Resulting value commonly termed book value.