Depreciation

1
Depreciation Asset Valuation(Chapter 4)
2
Objectives

• Define depreciation.
• Illustrate the different methods of computing
  depreciation.
• Show the importance of depreciation in a complete
  set of records.
• Outline some different methods used to value farm
  and ranch assets.

3
Depreciation

• Depreciation is an annual, non-cash expense to
  recognize the amount by which an asset loses
  value due to use, age, and obsolescence.
• Spreads the original asset cost over the assets
  useful life.

4
Depreciation Methods

• Straight Line.
• Sum-of-the-Years Digits (SYOD).
• Declining Balance.
• Partial-Year Depreciation.
• Note a method available for tax purposes called
  the Modified Accelerated Cost Recovery System
  (MACRS) will be discussed in Chap. 16.

5
Straight Line

• Easy to use
• Gives the same annual depreciation for each full
  year of an assets life.
• Annual depreciation (Cost - Salvage value)
• Useful life
• OR (Cost - Salvage)
  X R
• Where R (100 useful life) annual rate

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Straight Line(an example)

• Asset cost 100,000
• Asset life 20 years
• Salvage value 20,000
• Annual depreciation
• (100,000 - 20,000) 4,000
• 20
• b) R (100 20) 5
• (100,000 - 20,000) X .05 4,000

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Sum-of-the-Years Digits (SOYD)

• Annual depreciation
• (Cost - Salvage value) X RL
• SOYD
• RL remaining years of useful life as of the
  beginning of the year.
• SOYD sum of all the numbers from 1 through
  the estimated useful life.

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Sum-of-the-Years Digits (an example)

• Asset cost 50,000
• Asset life 5 years
• Salvage value 10,000
• Annual Depreciation
• Year 1 (40,000) X (5/15) 13,333.32
• Year 2 (40,000) X (4/15) 10,666.68
• Year 3 (40,000) X (3/15) 8,000.00
• Year 4 (40,000) X (2/15) 5,333.33
  
• Year 5 (40,000) X (1/15) 2,666.67

9
Declining Balance

• Annual depreciation
• (Book value at beginning of year) X R
• R a constant percentage value or rate.
• R is some multiple of the SL Rate
• For example, double declining balance 2 x SL
  rate.
• For example, 150 declining balance 1.5 x SL
  rate.
• The same R value is used each year.
• The book value declines each year by the amount
  equal to the previous years depreciation.

10
Double Declining Balance(an example)

• Asset cost 50,000
• Asset life 5 years (SL rate 20)
• Salvage value 10,000
• Annual Depreciation
• Year 1 50,000 X 0.40 20,000
• Year 2 (50,000 - 20,000) X 0.40 12,000
• Year 3 (30,000 12,000) X 0.30 7,200
• Year 4 (remaining depreciation) 800
• Year 5 no depreciation left 0

11
Partial-Year Depreciation

• An asset purchased during the year should have
  the first years depreciation prorated according
  to the length of time it was actually owned
• For example, owned for 3 months 0.25 of one
  years depreciation.

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Fast versus Slow Depreciation

• Fast depreciation
• Relatively high depreciation in the early years.
• Double Declining Balance
• SOYD
• Slow depreciation
• Relatively low depreciation in the early years.
• Straight Line

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Comparing Depreciation Methods(textbook example)
Note early end
14
Economic Versus Tax Depreciation

• Economic Depreciation
• The decline in value due to an assets reduced
  ability to produce revenue now and in the future.
• For management decisions??

• Tax Depreciation
• Tax regulations contain different methods for
  computing depreciation.
• Annual depreciation may be higher in early years
  than the true economic depreciation.
• For tax decisions??

15
Valuation of Assets(General Rules)

• Be conservative
• Dont place too high a value on an asset.
• Be consistent and use the same valuation method
• Makes financial statements comparable from year
  to year.
• Prevents an overly optimistic view of the firms
  financial condition
• Remember who the information is for!

16
Valuation Methods

• Market Value
• Cost
• Lower of Cost or Market
• Farm Production Cost
• Cost Less Accumulated Depreciation
• (commonly called book value.)

17
Market Value

• Values an asset using its current market price
• Normal marketing charges such as transportation
  and selling commissions are subtracted to find
  the net market value.
• Best for assets that can or will be sold as a
  normal part of business activities in a
  relatively short period of time, with current
  market prices readily available
• Hay, grain, feeder livestock, stocks or bonds.

18
Cost

• Valuing assets at their original cost.
• Best for assets that have been purchased
  recently
• Land, feed, fertilizer, supplies, purchased
  feeder livestock.
• Shouldnt be used for
• Buildings, machinery, raised livestock, and crops

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Lower of Cost or Market

• Valuing an asset at both cost and market value
  and using the lower value.
• Conservative method.
• Eliminates any increase in value caused by
  inflation.

20
Farm Production Cost

• Assets produced on the farm can be valued at
  their farm production cost.
• Should not include profit or opportunity costs.
• Need good cost-of-production records.
• Conservative valuation.
• Grain, silage, hay, raised livestock, immature
  crops.

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Cost Less Accumulated Depreciation

• Used for depreciable assets
• Machinery
• Buildings
• Purchased breeding livestock
• Same as its current book value.

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Summary

• A depreciation schedule is a necessary part of an
  accounting system.
• The total annual depreciation expense is
  necessary for computing annual profit.
• The three most common methods of depreciation
  are
• Straight Line, SOYD, and Declining Balance
• Depreciation for tax purposes uses different
  methods, and these values may not be the best
  choice to use in an accounting system used for
  making management decisions.
• Several methods used to establish value on
  assets, and method used depends on asset.