Depriciation Methods

17-12-2010
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Depreciation and Asset
Valuation
Chapter 4
Management in Ag/ARE 211
Depreciation
♦ Machinery, buildings, and similar assets are
purchased b/c they are required or helpful in
the production of farm products, which in
turn produce revenue
– Over time they grow old, wear, out, and
become less valuable
• This loss in value is considered a business expense
b/c it is a direct result of the asset’s use in producing
revenue & profit
Depreciation
♦ Often defined as the annual loss in value due to
use, wear, tear, age.
– It is both a business expense that reduces annual profit
and a reduction in the value of the asset
♦ To be depreciable, an asset must have the
following characteristics:
– A useful life of more than one year
– A determinable useful life but not an unlimited life
– Used in a business in order for the depreciation to be a
business expense
• Loss in value on a personal automobile or residence is not a
business expense
Examples of depreciable assets
on a farm
♦ Vehicles
♦ Machinery
♦ Equipment
♦ Buildings
♦ Land is NOT a
depreciable asset b/c it
has an unlimited life
g – Some improvements to
♦ Fences
♦ Livestock
♦ Irrigation wells
♦ Purchased breeding
livestock
land, though, can be
depreciated like
drainage tile
Depreciation Terms
♦ Cost – price paid for
assets, including tax,
delivery fees, and
installation
♦ Useful life number
– Difference between
cost & salvage value is
depreciable
♦ Book value – asset
– t i
of years expected to be
used in business
♦ Salvage value –
expected market value
at end of estimated
useful life
cost minus
accumulated
depreciation
Depreciation Methods
♦ No single correct method to use
♦ Depends on type of asset, pattern of use,
and how quickly its market value declines
1. Straight line – same annual depreciation
for each full year of an assets life
• Annual depreciation = (cost – salvage value) / useful life
• Example: purchase a machine for $24,000, assign it
a $4,000 salvage value and a 10 year useful life
9/29/2008
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Depreciation Methods
2. Sum-of-the-year’s digits (SOYD) – annual
depreciation is highest in first year
• Annual depreciation = (cost – salvage value) x (RL/SOYD)
• RL = remaining years of useful life as the beginning of the year of
which depreciation is being computed
• SOYD = sum of all the numbers from 1 thru the estimated useful
life
• Example: for a 5-year useful life, SOYD would be
1+2+3+4+5 = 15
• What would it be for a 10-year useful life?
• A quick way to find the SOYD is [(n)(n+1)] / 2
where n is the useful life
• See page 60 for detailed example
Depreciation Methods
3. Declining balance (Double declining)
• Annual depreciation = (book value at beginning of year) x R
• R = a constant percentage value or rate
• See page 61 in book for example
4. Partial year depreciation – when an asset is
acquired during an accounting period it
must be pro-rated
MACRS
Modified Accelerated Cost Recovery System
♦ Determine an asset’s useful life
– Each depreciable asset is assigned to a particular class,
depending on the type of asset
• Farm assets generally fall into the 3-, 5-, 7-, 10-, 15-, or 20-
year classes. Some examples are:
– 3-year: breeding hogs
– 5-year: cars, pickups, breeding cattle & sheep, dairy cattle,
computers, trucks
– 7-year, most machinery and equipment, fences, grain bins, silos,
furniture
– 10-year: single-purpose ag and hort structures, trees bearing fruit
or nuts
– 15-year: paved lots & drainage tile
– 20-year: general purpose buildings, machine sheds & hay barns
MACRS
♦ MACRS is an assumed salvage value of
zero for all assets
– Therefore, tax payers do not have to select a
useful life and salvage value when using
MACRS
Depreciation Worksheet
♦ In class assignment - handout
Valuation of Assets
♦ Estimation of the value of business assets
– Several valuation methods can be used
• Conservatism = cautions against placing too high a
value on any asset
• Consistency = stresses using the same valuation
method over time
9/29/2008
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Valuation Methods
♦ Market value
– Values an asset using its
current market price
♦ Cost
– Items that have been
♦ Farm production cost
– Items produced on the farm
can be valued a their farm
production cost
♦ Cost less accumulated
purchased can be valued at
their original cost
♦ Lower of cost or market
– Requires valuing an item at
both its cost and its market
value and then using
whichever value is lower
depreciation
– Can be used only for
depreciable assets such as
machinery, buildings, and
purchased breeding
livestock
Review Questions
♦ What makes a depreciation method “fast” or
“slow”?
– Give an example of each
♦What are the advantages and disadvantages
of each valuation method?