Depreciation

Contents

• Introduction
  
  
• LeasePak Depreciation Methods
  
  
  • Accelerated Cost Recovery System (ACRS)
    
    
  • ADR 150% Declining Balance
  • ADR 200% (Double) Declining Balance
  • ADR Straight Line
  • ADR Sum of the Years’ Digits (SOYD)
    
    
  • Bypass
    
    
  • Declining Balance 125%
  • Declining Balance 150%
  • Declining Balance 175%
  • (Double) Declining Balance 200%
    
    
  • DVA1 and DVA2 (Australian)
    
    
  • Modified Accelerated Cost Recovery System (MACRS)
    • Half-Year Convention
    • Mid-Quarter Convention
      • First Quarter
      • Second Quarter
      • Third Quarter
      • Fourth Quarter
        
        
  • Straight Line
  • Straight Line Half Year Convention
  • Straight Line Mid-month Convention
    
    
  • Sum of the Years’ Digits (SOYD)

Introduction

Depreciation is an annual tax deduction intended to reflect the decline of an asset’s value over time. This decline in value can be caused by physical deterioration due to usage, obsolescence, etc. Depreciation also serves to distribute the cost of an asset over the period of its use. Therefore, not only does depreciation reduce a company’s taxable income, it also helps to give a more accurate picture of a company’s worth.

The components of depreciation are:

• NET COST
  How much is the asset worth when it starts being depreciated?

• USEFUL LIFE
  What should the useful life of the asset be?

• SALVAGE VALUE
  What is a good estimate of the asset’s value at the end of its useful life?

• DEPRECIATION METHOD
  How should the depreciation be spread out over the asset’s useful life?

All these terms are defined for accounting (book) purposes, and may or may not exactly portray the true useful life, salvage value, etc. of the asset.

The NET COST less the SALVAGE VALUE is the allowable depreciation amount. In other words, that difference is the total amount of depreciation claimed over the useful life of the asset. In federal depreciation methods beginning with the Accelerated Cost Recovery System (ACRS) established under the Economic Recovery Tax Act of 1981 (ERTA), SALVAGE VALUE is always considered to be zero. In other words, the allowable depreciation amount is the NET COST of the asset.

The NET COST of an asset subtracted from its accumulated (life-to-date) depreciation yields the book value of the asset. Therefore, the book value for a given item depends on the DEPRECIATION METHOD that is chosen.

Book value should never fall below the SALVAGE VALUE. Book value reaches the SALVAGE VALUE if and only if all the allowable depreciation has been taken. All allowable depreciation is taken by the end of the asset’s USEFUL LIFE.

Accelerated Cost Recovery System (ACRS)

This is the federal depreciation method established by the Economic Recovery Tax Act of 1981 and amended by the Tax Equity and Fiscal Responsibility Act of 1982. It applies to all tangible property placed in service after December 31, 1980.

Under this method, all assets are placed in one of the following classes:

• 3-year property
  This class includes property with a present class life for 4 years or less, such as automobiles, light-duty trucks, and tractor units for use over-the-road.
  
  
• 5-year property
  This class includes property that is not 3-year, 10-year, or 15-year public utility property, such as computers and peripherals, office furniture and fixtures, office equipment, etc.
  
  
• 10-year property
  This class includes property with a present class life of 12.5 years or less, such as utility property, mobile homes, manufactured homes, railroad tank cars, etc.
  
  
• 15-year property
  This class includes property with a present class life of more than 12.5 years, such as buildings that do not fall under the 5- or 10-year property category.

An asset is entitled to depreciation for a year if it is active at any time during that year and is not disposed of during that same year. There is no salvage value required for assets under ACRS. That is, all assets are depreciated to a zero book value.

The Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) introduced the concept of reducing the taxable basis of an asset if the full amount of Investment Tax Credit available is retained by the lessor. This concept is discussed in detail in the Investment Tax Credit section.

Like the Modified Accelerated Cost Recovery System (MACRS), this method uses predetermined percentage tables to calculate the amount of depreciation to record each year. The percentage table is based upon the recovery period of the lease. These recovery periods also determine the amount of Investment Tax Credit ITC that may be claimed.

The following table shows the depreciation percentage of the taxable basis allowable under the ACRS method for each of the four class lives:

ADR 150% Declining Balance

ADR 150% Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is one and one-half times the straight line rate.

This method differs from the 150% Declining Balance method in that it does not recalculate the life-to-date depreciation each month. Instead, it calculates the monthly depreciation and adds it to the year-to-date and life-to- date figures. This is done because, under ADR methods, the depreciation method may be changed during the asset’s life. If a change occurs, life-to- date depreciation cannot be reconstructed by LeasePak. Another ramification of the ADR computational method is that catch-up depreciation accruals are not possible.

The ADR 150% Declining Balance method is calculated on a month-to- month basis.

ADR 200% (Double) Declining Balance

ADR 200% (Double) Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is twice the straight line rate.

This method differs from the 200% (Double) Declining Balance method in that it does not recalculate the life-to-date depreciation each month. Instead, it calculates the monthly depreciation and adds it to the year-to-date and life-to-date figures. This is done because, under ADR methods, the depreciation method may be changed during the asset’s life. If a change occurs,

life-to-date depreciation cannot be reconstructed by LeasePak. Another ramification of the ADR computational method is that catch-up depreciation accruals are not possible.

The ADR 200% Declining Balance method is calculated on a month-to- month basis.

ADR Straight Line

ADR Straight Line is one of the most conservative depreciation methods. An equal amount of depreciation is earned in each stage of the asset’s life.

This method differs from the Straight Line method in that it does not recalculate the life-to-date depreciation each month. Instead, it calculates the monthly depreciation and adds it to the year-to-date and life-to-date figures. This is done because, under ADR methods, the depreciation method may be changed during the asset’s life. If a change occurs, life-to-date depreciation cannot be reconstructed by LeasePak. Another ramification of the ADR computational method is that catch-up depreciation accruals are not possible.

The Straight Line method is calculated on a month-to-month basis.

ADR Sum of the Years’ Digits (SOYD)

ADR Sum of the Years’ Digits (SOYD) is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life.

This method differs from the Sum of the Years’ Digits (SOYD) method in that it does not recalculate the life-to-date depreciation each month. Instead, it calculates the monthly depreciation and adds it to the year-to-date and life-to-date figures. This is done because, under ADR methods, the depreciation method may be changed during the asset’s life. If a change occurs, life-to-date depreciation cannot be reconstructed by LeasePak. Another ramification of the ADR computational method is that catch-up depreciation accruals are not possible.

The ADR Sum of the Years’ Digits (SOYD) method is calculated on a month-to-month basis.

Bypass

Depreciation calculations may be bypassed for an asset by using this method. Tax-exempt, conditional sales, or loan transactions can be handled in LeasePak by bypassing the depreciation calculations.

Declining Balance 125%

125% Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is one and one-quarter times the straight line rate.

This method recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year-to-date depreciation.

The 125% Declining Balance method is calculated as follows:

The calculation:

Tax Basis minus nth Year Depreciation

cannot be less than the Salvage Value. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. "nth" Year Depreciation is the depreciation calculated during the nth year.

Declining Balance 150%

150% Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is one and one-half times the straight line rate.

This method differs from the ADR 150% Declining Balance method in that it recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year-to-date depreciation. The ADR group of depreciation methods do not recalculate life-to-date depreciation. Refer to the section on the ADR methods for more information.

The 150% Declining Balance method is calculated as follows:

The calculation:

Tax Basis minus nth Year Depreciation

cannot be less than the Salvage Value. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. "nth" Year Depreciation is the depreciation calculated during the nth year.

Declining Balance 175%

175% Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is one and three-quarters times the straight line rate.

This method recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year-to-date depreciation.

The 175% Declining Balance method is calculated as follows:

The calculation:

Tax Basis minus nth Year Depreciation

cannot be less than the Salvage Value. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. "nth" Year Depreciation is the depreciation calculated during the nth year.

(Double) Declining Balance 200%

200% Declining Balance is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life. The rate of depreciation earned is twice the straight line rate.

This method differs from the ADR 200% (Double) Declining Balance method in that it recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year-to-date depreciation. The ADR group of depreciation methods do not recalculate life-to-date depreciation. Refer to the section on the ADR methods for more information.

The 200% Declining Balance method is calculated as follows:

The calculation:

Tax Basis minus nth Year Depreciation

cannot be less than the Salvage Value. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. "nth" Year Depreciation is the depreciation calculated during the nth year.

DVA1 and DVA2 (Australian)

These methods are characterized as diminishing value methods for Book and Federal depreciation. The two methods are primarily used to depreciate the maximum cost of an asset.

• DVA2 Standard Australian Version of Diminishing Value Depreciation;

Cost of Asset = $10,000
Diminishing Value Rate = 10%

(Fiscal year-end and Asset in-service date are not elements of DVA2 calculation.)

1st month = 10,000.00 x 10%/12) = 83.33
2nd month = 10,000.00 x 10%/12) = 83.33
3rd month = 10,000.00 x 10% /12) = 83.33
(1st to 12th month Depreciation has the same amount and 1st year depreciation =

12 x 83.33=999.96
13th month depreciation = (10,000.00 - 1st year) x 10% /12 = (10,000.00 - 999.96) x 10% /12= 75.00
14th month depreciation = (10.000.00 - 999.96) x 10% /12 = 75.00
(13th and 24th month has the same amount and the 2nd year depreciation = 12 x 75.00 = 900.00

25th month depreciation = (10,000.00 - 1st year depreciation -2nd year depreciation) x 10% /12 = (10,000.00 - 999.96 - 9000.00) x 10% /12 = 67.50}
(25th to 36th month depreciation has the sam amount of 67.50

• DVA1 Orix Australia Version of Diminishing Value Depreciation:

  Asset Cost = 10,000.00
  Diminishing Rate = 10%
  Fiscal year End = 3/31
  Asset In-service Date = 1/98

  In the first year, DVA1 method takes 6 months worth of depreciation spread evenly over the first fiscal year from the asset in-service date. After the first fiscal year, it follows the rule of DVA2

First Fiscal Year

Jan 98 depreciation = 10,000 x 10% /12 x 6/3 = 166.67

6 = six months worth of depreciation
3 = three months left in the current fiscal year, Jan, Feb and Mar.

Feb 98 depreciation = 10,000 x 10% /12 x 6/3 = 166.67
Mar 98 depreciation = 10,000 x 10% /12 x 6/3 = 166.67

Total depreciation in the 1st fiscal year depreciation is 3 x 166.67 = 500.00

Second Fiscal Year

April 98 depreciation = (10,000 - 1st fiscal year depreciation) x 10% /12= (10,000 - 500) x 10% /12 = 79.17
May 98 depreciation = (10,000 - 500) x 10% /12 = 79.17
June 98 depreciation = (10,000 - 500) x 10% /12 = 79.17
(depreciation amount from April 98 to March 99 will have the same amount of 79.17)

Total depreciation in the 2nd fiscal year is 79.17 x 12 = 950.04

Third Fiscal Year

April 99 = (10,000 -1st fiscal yr. dep. - 2nd fiscal yr dep) x 10% /12= (10,000 -500 -950.04) x 10% /12 = 8549.96 x 10% /12= 71.25
May 99 = (10,000 - 500 - 950.04) x 10% /12 = 71.25
June 99 = (10,000 - 500 - 950.04) x 10% /12 = 71.25
(depreciation amount for April 99 to March 00 will be the same at 71.25)

Modified Accelerated Cost Recovery System (MACRS)

• Half-Year Convention
  
  
• Mid-Quarter Convention
  • First Quarter
  • Second Quarter
  • Third Quarter
  • Fourth Quarter
    
    
• Bonus Depreciation

This federal depreciation method was established by the Tax Reform Act of 1986. It replaced the Accelerated Cost Recovery System (ACRS) method, established by the Economic Recovery Tax Act of 1981 as amended by the Tax Equity and Fiscal Responsibility Act of 1982. MACRS applies to all tangible property placed in service after December 31, 1986. However, it may be elected for property placed in service after July 31, 1986, on an asset-by-asset determination.

Under this method, all assets are placed in one of the following classes:

• 3-year property
  This class includes property with an ADR class life of 4 years or less, such as tractor units for use over-the-road.
  
  
• 5-year property
  This class includes property with an ADR class life of more than 4 but less than 10 years, such as automobiles, light general purpose trucks, computers and peripherals, office machinery, etc.

• 7-year property
  This class includes property with an ADR class life of more than 10 but less than 16 years, such as office furniture and fixtures, etc. This class also includes any property which does not have a class life.

• 10-year property
  This class includes property with an ADR class life of more than 16 but less than 20 years, such as vessels, barges, tugs, etc.

• 15-year property
  This class includes property with an ADR class life of more than 20 but less than 25 years, such as municipal wastewater treatment plants, etc.

• 20-year property
  This class includes property with an ADR class life of 25 years or more, such as farm buildings, etc.

This method uses predetermined percentage tables to calculate the amount of depreciation to record each year. The basis for the tables is as follows:

• For property in a 3-, 5-, 7-, or 10-year class, use the 200% (Double)Declining Balance method (with a half-year convention). At the optimum point, switch to a straight line method. The optimum point is the first tax year when the straight line method yields a larger deduction than the 200% (Double) Declining Balance method.
  
  
• For property in a 15- or 20-year class, use the 150% Declining Balance method (with a half-year convention). At the optimum point, also switch to a straight line method.

There is no salvage value required for assets under MACRS. That is, all assets are depreciated to a zero book value.

Half-year Convention

The half-year convention normalizes the in-service date of assets to the mid-point of the tax year. In other words, it treats an asset placed in service during the year as if it was placed in service in the middle of the tax year. It does this by:

Allowing a half-year of depreciation in the first year the asset is placed in service. Assets placed in service in January and December are allowed the same amount of depreciation (a half-year’s worth).

• For each following year of the recovery period, a full year’s worth of depreciation is allowed.
• If the asset is held for the entire recovery period, a half-year of depreciation is allowed for the year following the end of the recovery period (e.g., the fourth year of 3-year property).
• If, however, the asset is disposed of in the first recovery year, no depreciation is taken.
• For assets disposed of in subsequent years, only a half year of depreciation would be accounted for in the year of disposition.

Mid-quarter Convention

• First Quarter
• Second Quarter
• Third Quarter
• Fourth Quarter

The MACRS method also provides for a mid-quarter convention. If during any one tax year the total of all property placed in service in the last three months of the fiscal year exceeds 40% of the total of all property placed in service during the whole year, the mid-quarter convention must be used instead of the half-year convention. Like the half-year convention, the mid- quarter convention normalizes the in-service date of assets to the mid-point of the quarter. It does this by:

• Allowing a mid-quarter of depreciation for the quarter the asset is placed in service during the first year. For example, an asset placed in service on December using mid-quarter fourth quarter convention would account for a total of 4 and a half months of depreciation in the first year.
• For each following year of the recovery period, a full year’s worth of depreciation is allowed.
• If the asset is held for the entire recovery period, a half-quarter depreciation is allowed for the last quarter of the year following the end of the recovery period. For example, asset placed in service on December using mid-quarter in fourth quarter convention of a 3-year property, the fourth year depreciation would only account for 10 1/2 months of depreciation.
• If, however, the asset is disposed of in the first recovery year, no depreciation is taken.

For assets disposed of in the subsequent years the following rules apply:

The following percentages apply towards the full year’s depreciation amount.

The following tables show the depreciation percentage of the taxable basis allowable under the MACRS method for each of the six class lives.

MACRS: Mid-Quarter (in service first quarter)

MACRS: Mid-Quarter (in service second quarter)

MACRS: Mid-Quarter (in service third quarter)

MACRS: Mid-Quarter (in service fourth quarter)

MACRS: Bonus Depreciation

Under the Job Creation and Workers Assistance Act of 2002, taxpayers are now entitled to an additional first-year depreciation deduction equal to 30% of the adjusted basis of qualified property. LeasePak has 123 new methods that will allow the 30% bonus to be taken during the first year. The eligible property includes:

• Property depreciated under MACRS with a recovery period of 20 years or less;
• Water utility property;
• Computer software other than software that must be amortized over 15 years;
• Qualified leasehold improvements (generally a non-structural, non-expansion improvement to an interior portion of an existing nonresidential building).
  

In order to qualify, the property must be acquired after September 10, 2001, and before September 11, 2004. First use of the property must begin on or after September 11, 2001 and be placed in service before January 1, 2005. The additional first-year depreciation is allowed for both regular tax and AMT purposes for the tax year in which the property was placed in service. The basis of the property is reduced by the additional first-year depreciation.

The Federal Depreciation Report [R0304a] will reflect the Bonus Depreciation in the Depreciation Expense YTD column, as well as the YTD depreciation (calculated on the Federal Basis less the Bonus) for the first year only. Depreciation Expense YTD will be cleared at Year End.

The Accum Deprec LTD will contain the Bonus Depreciation. It will NOT be cleared at Year End. The YTD AMT Depr Diff will reflect the Bonus Depreciation.

The Federal Tax Basis will remain the same for the report; however, the depreciation will be calculated on the Federal Tax Basis less the 30% Bonus Depreciation. Gain/Loss Report [R0311] will reflect the Bonus Depreciation. If the Federal Depreciation Basis is reduced and the Accum Deprec LTD both reflects the Bonus Depreciation, the Gain/Loss will be overstated.

Because some states have not enacted the IRS provisions, the State Depreciation Report [R0304b] will not calculate the 30% bonus; it will remain as is. The user will have the ability to change the method to/from the Bonus depreciation, DURING THE CURRENT YEAR ONLY, through U0120, Change Depreciation.

Depreciation Adjustments Regular

Depreciation Adjustments AMT

Straight Line

Straight Line is one of the most conservative depreciation methods. An equal amount of depreciation is earned in each stage of the asset’s life.

This method differs from the ADR Straight Line method in that it recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year- to-date depreciation. The ADR group of depreciation methods do not recalculate life-to-date depreciation. Refer to the section on the ADR methods for more information.

The Straight Line method is calculated as follows:

AGE * (TAX BASIS - SALVAGE VALUE) / USEFUL LIFE

Age is the number of months from the in-service date to the accrued to date. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. Useful Life is the recovery period of the asset. For the straight line over term method, useful life is the actual term of the lease.

Straight Line Half Year Convention

Straight Line Half Year Convention is one of the most conservative depreciation methods. An equal amount of depreciation is earned in each stage of the asset’s life.

This method differs from the ADR Straight Line method in that it recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year- to-date depreciation. The ADR group of depreciation methods do not recalculate life-to-date depreciation. Refer to the section on the ADR methods for more information.

The Straight Line method is calculated as follows during the first fiscal year:

(TAX BASIS - SALVAGE VALUE) / USEFUL LIFE) * (AGE / MONTHS) * 6

Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. Useful Life is the recovery period of the asset. Age is the number of months from the in-service date to the accrued to date. Months is the number of months the asset is in-service during the first fiscal year.

After the first fiscal year the following calculation is used for the Straight Line method:

AGE * (TAX BASIS - SALVAGE VALUE) / USEFUL LIFE

Age is the number of months from the in-service date to the accrued to date. Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. Useful Life is the recovery period of the asset.

Straight Line Mid-month Convention

Sum of the Years’ Digits (SOYD)

Sum of the Years’ Digits (SOYD) is an accelerated depreciation method. That is, a higher amount of depreciation is earned in the earlier stages of the asset’s life.

This method differs from the ADR Sum of the Years’ Digits (SOYD) method in that it recalculates the life-to-date depreciation each month (based upon the in service date and the current date) in order to determine the month-to-date and year-to-date depreciation. The ADR group of depreciation methods do not recalculate life-to-date depreciation. Refer to the section on the ADR methods for more information.

The Sum of the Years’ Digits (SOYD) method is calculated as follows:

(TAX BASIS - SALVAGE VALUE) * (REMAINING LIFE / SUM USEFUL LIFE)

Tax Basis is the amount from which depreciation is deducted. This is usually the original purchase price. Salvage Value is the value of an asset at the end of its useful life. Remaining Life is the number of years remaining in the useful life of the property. Sum Useful Life is the sum of the useful life years. For example, the Sum Useful Life is 15 for an asset with a useful life of 5 years (1 + 2 + 3 + 4 + 5 = 15).

© 2001 by McCue Systems Incorporated.
All rights reserved.

The information contained in this document is the property of McCue Systems, Inc. Use of the information contained herein is restricted. Conditions of use are subject to change without notice. McCue Systems, Inc. assumes no liability for any inaccuracy that may appear in this document; the contents of this document do not constitute a promise or warranty. The software described in this document is furnished under license and may be used or copied only in accordance with the terms of said license. Unauthorized use, alteration, or reproduction of this document without the written consent of McCue Systems, Inc. is prohibited.