5Q Finance and Acct

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Construction
Accounting
and Financial
Management
CHAPTER 5

DEPRECIATION

1

Purpose

� Financial statements

� Cost allocation of equipment

� Taxes

Depreciation is the loss in value of a piece of equipment or real property

Different depreciation schedules may be used for the preparation of
financial statements, the billing of equipment, and the preparation of
income taxes, which may result in very different depreciation rates.

Purpose – cont’d

� Straight-line method

� Declining-balance method

� Sum-of-Years method

For the preparation of financial statements and the billing of
equipment, there are three commonly used methods of depreciation.

Variables

� P = Purchase price of the asset

� F = Salvage Value of the asset (this is estimated resale value of the
asset at some time in the future when it is sold.)

� Zero for tax purposes – For tax purposes, the salvage value is
assumed to be zero.

� N = Recovery period (years)

� Set by code for tax purposes

� Rm = Percentage of depreciation taken in year m

� Dm = Depreciation for year m

� BVm = Book value at the end of year m

� Book value equals the purchase price less the depreciation recorded
to date

Each of the three commonly used methods to calculate
depreciation, use the following variables:

Straight-Line Method

� Depreciates uniformly over the life of the asset

� Annual depreciation

Dm = (P – F)/N

� Book Value

BVm = P – m(Dm)

-or-

BVm = BVm-1 – Dm

� Rate of Depreciation

Rm = 1/N

Straight-Line

m R
m

D
m

($) BV
m

($)

0 110,000

1 1/5 20,000 90,000

2 1/5 20,000 70,000

3 1/5 20,000 50,000

4 1/5 20,000 30,000

5 1/5 20,000 10,000

A dump truck is purchased for $110,000 and has an estimated salvage value
of $10,000 at the end of the recovery period. Prepare a

depreciation

schedule for the dump truck using the straight-line method with a recovery
period of 5 years.

Dm = (P – F)/N BVm = BVm-1 – Dm

Sum-of-the-Years (SOY)

� Accelerates depreciation of an asset

� Annual depreciation
Dm = (P – F)Rm
Rm = (N – m + 1)/SOY
SOY = N(N + 1)/2

� Book Value
BVm = BVm-1 – Dm

Sum-of-the-Years (SOY)
m R
m
D
m
($) BV
m
($)

0 0 110,000

1 5/15 33,333 76,667

2 4/15 26,667 50,000

3 3/15 20,000 30,000

4 2/15 13,333 16,667

5 1/15 6,667 10,000

A dump truck is purchased for $110,000 and has an estimated salvage value
of $10,000 at the end of the recovery period. Prepare a depreciation
schedule for the dump truck using the sum-of-years method with a recovery
period of 5 years.

 Step 1 – Calculate SOY. SOY = N(N+1)/2 = 5(5 + 1)/2 = 5(6)/2= 30/2 = 15
 Step 2 – Calculate the Rate of Depreciation (Rm )= (N-m+1)/SOY = (5 -1+ 1)/15 = 5/15
 Step 3 – Calculate Depreciation = Dm = (P-F) Rm = ($110,000-$10,000)* 5/15 = $33,333
 Step 4 – Calculate Book Value = BVm = BVm-1 – Dm == ($110,000-$33,333) = $76,667

Declining-Balance Method

� Accelerates depreciation

� Annual depreciation
Dm = (BVm-1)Rm

� Rm = 2.00/N for 200% declining-balance

� Rm = 1.50/N for 150% declining-balance

� Book Value
BVm = BVm-1 – Dm

Declining-Balance Method

� Does not automatically reach salvage value

� Must stop depreciation at salvage value when
book value goes below salvage value

– or –

� Must switch to straight-line depreciation when the
straight-line depreciation for the remaining years
is greater than declining-balance depreciation

Declining-Balance Method
A dump truck is purchased for $110,000 and has an estimated salvage value
of $10,000 at the end of the recovery period. Prepare a depreciation
schedule for the dump truck using the 200% declining-balance method with a
recovery period of 5 years.

 Step 1a – Calculate the annual depreciation rate for each year under the
200% declining-balance method: Rm = 2.0 /N = 0.40

Using the example D1 = ($110,000)0.40 = $44,000

 Step 1b – Calculate Depreciation using Straight-line method= Dm = (P-F) /N
Using the example D1 = ($110,000 – $10,000)/5 =

$20,000

– Use the method of depreciation which produces the larger value.

 Step 2 – Calculate the Book Value = BVm = BVm-1 – Dm = (110,000 – $44,000)/5 = $66.000
Continue Step 1a and Step 1b then, use the larger of the depreciation amounts
to calculate the Book Value. Switch to the straight-line method when the
depreciation calculated exceeds the depreciation calculated using the
declining-balance method for the remaining years.

Stopping at Salvage
Value ($20,000)

$0

$20,000

$40,000

$60,000

$80,000

$100,000

$120,000

0 1 2 3 4 5
Year

Declining Balance

Stopping at the
Salvage Value

Switching to

Straight Line

(SV = 0)

$0
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
0 1 2 3 4 5
Year
Declining Balance
Straight Line

MACRS
� Modified accelerated cost recovery system (MACRS)

� The IRS’s rules for depreciation

� Depreciation methods used:

� Double declining balance

� 150% declining balance

� Straight line

� Includes rules for placing and removing assets from service

Placing in Service

� Half-year

� General rule

� Does not apply to real property (real estate)

� Mid-quarter

� Must use when placing 40% or more of assets in
service during the last quarter

� Does not apply to real property (real estate)

� Mid-month

� For real estate

For tax purposes, a full year’s depreciation is not allowed by the IRS
during the tax year an asset is placed in service or disposed of. In most
cases, the IRS assumes that the asset was placed in service or disposed
of in the middle of the year and allows taxpayers to take 50% of the
annual depreciation for the first and last years of the recovery period.
This is known as the half-year convention.

IRS Recovery Periods

� Three-year: Rent-to-own property and tractors

� Five-year: Automobiles, light general propose
trucks, calculators, copiers, computer
equipment, concrete trucks, heavy general
purpose trucks, trailers, and other construction
assets

� Seven-year: Office furniture, office equipment,
and railroad tracks

� Ten-year: Vessels, barges, tugs, and other water
transportation equipment

� Fifteen-year: Retail motor fuel outlets

IRS Recovery Periods
� Twenty-year: Farm buildings

� Twenty-five-year: Municipal sewers, water
treatment plants, and water distribution lines

� Twenty-seven-and-a-half-year: Residential real
estate where more than 80% of the rent is derived
from the dwelling units

� Thirty-nine-year: Non-residential real estate

� Fifty-year: Railroad roadbeds, right-of-ways, and
tunnels

Use of Depreciation Tables

� Find correct table

� Find correct recovery period for asset across top of
table

� Percentages are percentage of asset value
depreciated during the year

� not the percent of the previous year’s book value

Use of Depreciation Tables
Table 5-6

Depreciation Rates for 200% Declining-Balance Using the Half-Year

Convention

Year 3 years (%) 5 years (%) 7 years (%) 10 years (%)

1 33.33 20.00 14.29 10.00

2 44.45 32.00 24.49 18.00

3 14.81 19.20 17.49 14.40

4 7.41 11.52 12.49 11.52

5 NA 11.52 8.93 9.22

6 NA 5.76 8.92 7.37

7 NA NA 8.93 6.55

8 NA NA 4.46 6.55

9 NA NA NA 6.56

10 NA NA NA 6.55

11 NA NA NA 3.28

IRS, Instructions for Form 4562, 2006, p. 13

Section 179
� Can expense up to $1,000,000 (for 2018) of equipment without

depreciation

{The Tax Cuts and Job Act increases the Section 179 deduction for
2018 allowing taxpayers to deduct up to $1,000,000 in equipment
costs without having to depreciate the equipment.}

� If the amount of Section 179 property placed in service exceeds
$2,500,000 the allowed write-off is generally reduced by the
difference between the amount of Section 179 property and
$2,500,000.

� EXAMPLE: If you placed $3,000,000 of Section 179 property in
service during the tax year, the allowable Section 179
deduction would be $1,000,000 minus the difference between
$3,000,000 and $2,500,000 ($500,000), or $500,000 ($1,000,000 –
$500,000). These limits will be adjusted for inflation annually.

QUESTIONS???

21

Robert R. Taylor School of Architecture and Construction Science

CSMT 360 – Construction Accounting and Finance Spring 2021

Homework 2

Chapter 5

Name:

NOTE: You must use proper grammar and complete sentences when answering questions in order to receive full credit.

1.Why would a company use the sum-of-the year or declining balance methods to calculate depreciation?

2. How many years does it take to depreciate a piece of equipment with a five year recovery period MACRS? Happen?

3. A piece of equipment purchased for $110,000 has an estimated salvage value of $10,000 at the end of the recovery period. Prepare a depreciation schedule for the piece of equipment using the straight-line method with a recovery period of seven years.

4. For the current tax year, 2021. are the maximum Section 179 deductions and the amount where Section 179 begins to be phased out?

5. A piece of equipment is purchased for \$40,000 and has an estimated salvage of 51, 000 at the end of the recovery period. Prepare a depreciation schedule the piece of the sum-of-the-years method with a recovery period of five years.