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Depreciation & Asset Valuation

Depreciation & Asset Valuation. 1.21.10. Depreciation. What is it? “Annual loss in value due to use, wear, tear, age, & technical obsolescence.” Business expense reducing annual profit Factor that determines value for depreciable assets

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Depreciation & Asset Valuation

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  1. Depreciation & Asset Valuation 1.21.10

  2. Depreciation • What is it? • “Annual loss in value due to use, wear, tear, age, & technical obsolescence.” • Business expense reducing annual profit • Factor that determines value for depreciable assets • Loss in value resulting from use of an asset in production system

  3. General Idea Asset has reduced life over time Its loss of value is a cost of production (business expense) Your taxes should reflect this So should your thinking Depreciation is a REAL cost If you ignore it you are fooling yourself Also when it wears out you must replace it – then what?

  4. Depreciable Assets • What are they? • Must fulfill 3 requirements • Useful life >1 year • Determinable life, but not unlimited • Use in a business • Examples • Machinery • Buildings • Breeding livestock • Land improvements

  5. Calculating Depreciation • What must you know? • Cost • $ paid to put the asset into production • Useful life • Salvage value • Another useful item to know • Book value

  6. Depreciation Methods • Types • Economic • Tax • How do you choose? • What is your ultimate purpose? • Management & decision making • Completing tax forms

  7. Depreciation Methods • Economic • Straight line • Declining balance • How do you choose? • Total depreciation $ stays the same under both methods • What type of asset is being depreciated?

  8. Straight Line • Annual depreciation (AD) = (cost – salvage value) / useful life OR • AD = (cost – salvage value) * R • R is annual straight line percentage rate • = 100 % / useful life

  9. A seven year asset (planter) worth 10,000 with no salvage value Life =7 1/7 = 0.1429 Example

  10. Declining Balance (Fast Depreciation) • AD = book value at beginning of year * R • Common • 150% • Double (200%) Idea – greatest loss of value up front – car

  11. A seven year asset (planter) worth 10,000 with no salvage value Life =7 Double depreciation 2*1/7 = 0.2857 Example

  12. Note – didn’t end up at zero Can use variable declining balance – take rest of value in last year Or switch to straight line when it is to your advantage

  13. Tax Depreciation • Modified Accelerated Cost Recovery System (MACRS) • IRS publications 225 & 946 • Framework • Implied salvage value = $0 • ½ yr depreciation allowed in purchase year • System of property classes determining useful life for the asset in question

  14. Like double declining balance until straight line becomes better Year 1 – half a year Year 8 – half a year

  15. Switch to straight line Remaining value/3.5years left

  16. Tax Depreciation

  17. Example • A small dairy processing cheese purchases a pasteurizer for their operation. This piece of equipment costs $27,900. • In what class does this item fall? • 7 year

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