Emm 3604 r My Depreciation
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Transcript of Emm 3604 r My Depreciation
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Depreciation
Is the decrease in value of physical
properties with use and time.
It is an accounting conceptan
annual deduction against before tax
income such that the effect of time
can be reflected in a firms financial
statement.
A non-cash cost that affects income
taxes.
Can involve deterioration or
obsolescence
Depreciation accounting is to
account for the cost of fixed assets in
a pattern that matches their decline
in value over time.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Asset Depreciation
Fixed Assetsresources that are
acquired to provide future cash
flows.
Depreciation
Economic depreciation
The gradual decrease inutility in an asset with useand time.
Accounting depreciationThe systematic allocation ofan assets value in portions
over its depreciable life
Physical dep
Functional dep
Book dep
Tax dep
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Physical depa reduction in an assets capacity to
perform its intended service due tophysical impairment. due tointeraction with environmentcorrosion, rotting and due to wear andtear of use.
Functional depas a result of changes in the
organization or in technology obsolescence, declining need of theasset, or inability to meet increasedquantity and/or quality demands.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Economic dep
Economic dep =purchase pricemarket
valueAccounting dep
use to assess financial position of
organization.
Asset dep, cost of fixed assets arecapitalizedtheir costs are distributed by
subtracting them as expenses from gross
income.
A fraction of the cost of the asset ischargeable as an expense in each
accounting period in which the asset
provide service to the firm.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Depreciation Concepts &
Terminology
Depreciating an asset requires:1. What is the cost of the asset
2. What is the assets value at the end of
its useful life3. What is depreciable life of an asset
4. What method of dep do we choose?
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Cont
Depreciable Propertya. It must be used in business or held toproduce income
b. It must have a definite service life,
and that life must be longer than ayear.
c. It must be something that wears out,
decays, get used up, obsolete, or
loses value from natural causes.
d. It is not inventory, stock in trade, or
investment property.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Definitions Adjusted (Cost) basis
original cost basis of the asset, adjustedby allowable increases or decreases. Ex.cost of any improvement to a capital
asset with a useful life greater than oneyear, the original cost basis. Casualtyor theft loss.
Basis, or cost basis initial cost of acquiring an asset
(purchase price + any sales taxes),including transportation expenses andother expenses making the assetserviceable.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Cont
Book Value (BV)the worth of a depreciable property shownon the accounting records of a company.
Original cost basis include anyadjustments, less all allowabledepreciation or depletion deductions.
(Book Value) = adjusted cost basis - (dep deduction)
Market Value (MV)the amount that will be paid by a willing
buyer to a willing seller. The MVapproximates the present value of whatwill be received through ownership of theproperty, including the time value ofmoney.
J=1
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Definitioncont
Recovery periodThe number of years over which the
basis of a property is recovered
through the accounting process.
Recovery rateA percentage (in decimal form) for
each year of the MACRS recovery
period that is utilized to compute anannual depreciation deduction.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Definitioncont
Recovery periodThe number of years over which the
basis of a property is recovered
through the accounting process.
Recovery rateA percentage (in decimal form) for
each year of the MACRS recovery
period that is utilized to compute anannual depreciation deduction.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Definitioncont
Salvage Value (SV) the estimated value of a property at the end of its
useful life. It is the expected value or selling priceof a property when the asset can no longer be usedproductively by its owner. The term net salvagevalue is used when expenses are incur in disposingproperty.
a cash outflow deducted from cash inflow to obtainfinal net SV.
Useful life the expected (estimated) period of time that a
property will be used to produce income/owners
expects to productively use it. Referred asDepreciable Life sometimes. Actual Useful Life ofan asset, maybe different than its depreciable life.Determine service life of an asset IRS guidelines.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Example:
A company purchased an automatic hole-punching
machine priced at RM62, 500. The vendors invoiceincluded a sales tax of RM3263. The company alsopaid the inbound transportation charges of RM725as well as labour cost of RM2150 to install themachine in the factory. The site was also preparedbefore installation at a cost of RM3500. Determinethe cost basis for the new machine for depreciationpurpose.
Cost of new machine RM62,500
Freight 725
Installation Labour 2,150
Site Preparation 3,500
Cost of machine (cost basis) RM68,875
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Depreciation Methods
1. Book dep - for financial reports,balance sheet, income statement.2. Tax dep - for calculating taxes.
depreciating assets more quickly
allows firms to defer paying income
taxes.
Permit a higher dep in earlier years
than book dep, tax benefit is enjoyed
earlier. Pay lower taxes in earlier years,
better cash position because of timevalue of the funds.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Book Depreciation Methods
EE -dep in the context of income
tax computation. firms use book dep methods for
financial reporting to stockholders and
outside parties to reflect the actualloss in value of asset
still use for income tax purposes.
1. straight line method
2. accelerated methodDB, SOYD.
3. unit of prod method
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Straight line method (SL)
Assumes fixed assets provides its
services in a uniform fashion.
A constant amount is depreciatedeach year over the useful life of
the asset.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SLcont
dk = (B - SVn) / N
d* = dfor 1 k N
BV = B - d
N =depreciable life of the assets in years
B =cost basis d =annual dep deduction in year (1
N)
BV=book value at the end of year
SV=estimated salvage value at end year N d* =cumulative dep through year
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SLexample
A new electric saw for cuttingsmall pieces of lumber in a
furniture manuf. Plant has a cost
basis of RM4000 and a 10-year
depreciable life. The estimated SV
of the saw is zero at the end of 10
yrs. Determine the annual dep
using SL and the BV at the end ofeach year.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SLexample (cont)
d = (40000) / 10
at year 5,
d5 = RM 400
d*5 = 5 (40000) =RM 2000
10
BV = 40005(4000-0)
10
= RM 2000
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SLexample (cont)
EOY, dk BVR
0 - RM 40001 RM400 3600
2 400 3200
3 400 2800
4 400 24005 400 2000
6 400 1600
7 400 1200
8 400 800
9 400 400
10 400 0
The final SV is the final book value
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Declining Balance (DB) method sometimes called constant percentage
method or the Matheson Formula. Assumes the annual cost of dep is a fixed
percentage of BV at the beginning of the
year.
The fixed fraction, is = (1/N) (multiplier)
Multiplier commonly used 1.5 (150% DB)
and 2.0 (200%, or DDB).
As N , dep is highest in thefirst year and decreases over the assets
depreciable life.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DBcont
D1 = Ii
D2 = (I D1) = I (1-)
D3 = (ID1- D2) = I (1)2
Dn = I (1-) n-1
Bn = I (1-) n
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DBExample
The following information for acomputer system:
Cost Basis of the asset, I =
RM10,000
Useful Life, N = 5 years.
Estimated SV = RM778.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DBExample (cont)
Use same example as SL:-a. = 2/N = 0.2
d6 = 4000 (1-0.2)5 (0.2) = RM262.14
d*6 = 4000 [ 1-(1-0.2)6 ] = RM2951.42
BV6= 4000 (1-0.2)6 = RM1,048.58
b. = 1.5/N = 0.15
d6 = 4000 ( 1- 0.15)5 (0.15) = RM266.22
d*6 = 4000 [ 1(1 - 0.15)6] = RM2491.40BV6 = 4000 (10.15)
6 = RM1508.60
Using = 0.2
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DBExample (cont)
EOY, d BV0 - 4000
1 800 3200
2 640 2560
3 512 20484 409.60 1638.40
5 327.68 1310.72
6 262.14 1048.58
7 209.72 838.86
8 167.77 671.09
9 134.22 536.87
10 107.37 429.50
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Sum of the yearsdigit (SOYD)
If N = depreciable life of the asset,SOYD = n (n+1)
2
d = (B - SVN) . [ 2 (N + 1) ]
N ( N + 1 )
Book Value
BV= B[ 2 ( B- SVN) ] + [ (B - SVN) ]
( + 1)N N ( N + 1 )
d* = B - BV
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SOYDexample
Using same ex:d4 = 400 [ 7 / 25 ], N = 10
= 509.09
SOYD = 10 (11) = 55
2
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
SOYDexample (cont)
EOY, d BV
0 - 4000
1 727.27 3272.73
2 645.55 2618.183 581.82 2036.36
4 509.09 1527.27
5 436.36 109.91
10 72.73 0
d1 = 4000 (10 / 55)
d2 = 4000 (9 / 55)
d3 = 4000 (8 / 55)
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DB switchover to SL
DB - BV never reaches
zero can switch to SL
Switchover occur when SLDep >
DBdep
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
DB switchover to SLex
d6 = RM262.14,
BV6 = RM1048.58
BV10 = RM429.50
With switchover, BV10 = 0, since
in year 6
Dbdep = SLdep= RM262.14
switch to SL
thru year 7-10, SLdep>DBdep
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Example (cont)
BOYear, DB SL BV
6 262.14 = 262.14 1310.72
7 209.72< 262.14 1048.58
8 167.77< 262.14 786.44
9 134.22< 262.14 524.3010 107.37< 262.14 262.16
Total depreciation :
DDB = RM3,570.50SL = RM4000.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Units of Production Method
SL, DB, SOYD -decrease in valueas a function of time.
When decrease in value is mostly afunction of use, the cost basis (minus
final SV) is allocated equally over theestimated number of units producedduring the useful life of the asset.The depreciation rate:
Depreciation per unit prod= B -SVN
estimated lifetime prod in units
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Example
A piece of equipment has a basis ofRM50,000 and SV is RM10,000, whenreplaced after 30,000 hrs. of use. Find thedep rate per hour of use, and its BV after10,000 hrs of operation.
Dep per unit ofprod
=RM50,00010,000 = RM1.33
30, 000
After 10, 000 hrs,BV = 50, 000 RM1.33 (10,000)
hr
Or BV = RM36, 700 #
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
MODIFIED ACCELERATED COST
RECOVERY SYSTEM (MACRS)
Practice in US
1981-ACRS 1986 - MACRS
asset dep law
dictate depreciation rates for allpersonal and real property
take advantage of accelerated methods
of capital recovery
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
MACRS (cont)
MACRS
Dt = dtB
dt = dep rate provided by
the Govt.Book Value,
BVt = BVt-1 - Dt
BVt = first costsum ofacc. dep
= B - Dj
j=t
j=1
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
MACRS (cont)
First cost B is always completely depreciated
as MACRS assumes that the estimated SV=0. Recovery periods are standardized to the
values of 3,5,7,10,15 and 20 years forpersonal property. For real property
commonly 39 years, possible to justify 27.5year recovery period.
For Annual Dep: First Cost (unadjusted)
X MACRS rate (from table).
the dep rate incorporate the DDB method (d= 2/n) and switch to SL dep during recoveryperiod for property starts with DDB (dt = 2/n) SL rate (dt = 1/n) when SL method offers afaster write-off.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
MACRS (cont)
Real property -SL method for n = 39.
Annual percentage dep rate =1/39 =0.02564. the MACRS forces partial
recovery in years 1 to 40.
Year 1 100 d1 =1.391%
Year 239 100 dt =2.564%
Year 40 100 d40 = 1.177%.
MARCS dep rates are presented for 1 yearlonger than stated recovery period n.
- is built in half year convention imposed bythe MACRS system.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement AnalysisWhy???a. Reduced Performance -
deterioration of parts, expected levelof reliability/productivity is notachieved, increased cost of operation,higher scrap and rework costs, lostsales, and larger maintenanceexpenses.
b. Altered requirements - Newrequirements accuracy, speed etc.
c. Obsolescence - competition, rapidlychanging technology of automation,computers, communication.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
Basic concepts -compare
alternatives.Defenderasset currently owned
(or in place).
Challenger(s)other alternative(s)Perspective - of analysis
consultant or outsider.
- neither own or use the asset
To acquire the defender, we must
invest the going market value of the
defender alternative.
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
Estimated market or trade-in-value
the First Cost of the defender
alternative.
- economic life, AOC & SV for defender
past cost are irrelevant inreplacement analysis
- includes sunk cost.
Sunk cost should not be included in
the economic analysis. It represents
capital loss.
Sunk cost = present BV-present MV
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
Time Value of Money
Interest- manifestation of the time value ofmoney
- the increase between an original sum of
money borrowed and final amount owed,original amount owned (investment) andfinal amount accrued.
Principal - original investment orloan amount.
Ifve lose money and no interest.
Interest=total amount now - original principal
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
If you borrowed money
Interest rate :Percent interest rate
= interest accrued per time unit x
100%
original amount
unit of time used - interest period
Interest =amount owed now-original principal
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
Examples1) Investment RM100, 000 and
withdrew a total of RM106, 000
exactly 1 year later.
a. Interest gained:
RM106, 000100, 000 = RM60, 000
b. Interest rate:
6000 / yr x 100% = 6% per year.
100,000
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EMM3604 Cost Accounting and Engineering EconomyAssoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis (cont)
2) You borrowed RM20,000 from a
bank for a year at 9% interest.
a. interest : RM20,000 (0.09) =
RM1800
b. Total due at end of year :
= sum of principal + interest
= RM20, 000 + RM1800
= RM 21,800
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Replacement Analysis (cont)
3) How much money has to be
deposited one year ago to have
RM1000 now at an interest rate of 5%
per year. What is the interest earned?Let X be the original deposit
Total = original + original
(interest rate)
RM1000= + ( 0.05) = (1+0.05)
= 1000 / (1.05) = RM952.38.