Depreciation and Depreciation Accounting 6 1 Introduction Engineering

  • Slides: 23
Download presentation
Depreciation and Depreciation Accounting

Depreciation and Depreciation Accounting

6. 1 Introduction • Engineering projects often involve investment in equipment or other assets.

6. 1 Introduction • Engineering projects often involve investment in equipment or other assets. These assets lose value, or depreciate, over time. • The first part of Chapter 6 deals with the concept of depreciation and methods of estimating depreciation. Copyright © 2006 Pearson Education Canada Inc. 2

6. 2 Depreciation • Assets depreciate for a variety of reasons: • Use related

6. 2 Depreciation • Assets depreciate for a variety of reasons: • Use related physical loss, e. g. tire wear on a car. This type of loss is usually measured as a function of units of production, miles driven, or other measures of use. • Time related physical loss: e. g. , rusting of cars. This type of loss is usually measured in units of time. • Functional loss : e. g. , style changes, changes in safety device requirements. This is usually measured in terms of the function lost. Copyright © 2006 Pearson Education Canada Inc. 3

6. 2. 2 Value of an Asset • • Depreciation models are commonly used

6. 2. 2 Value of an Asset • • Depreciation models are commonly used to model (estimate) the value of an asset at any point in time. The remaining value of an asset may be measured in a number of ways, depending on the circumstances: Copyright © 2006 Pearson Education Canada Inc. 4

6. 2. 2 Market Value • • Market Value: taken as the value of

6. 2. 2 Market Value • • Market Value: taken as the value of an asset in the open market, i. e. if it were for sale. Since we can only determine the market value by selling the asset, the market value usually refers to an estimate of the market value. Copyright © 2006 Pearson Education Canada Inc. 5

Book Value • Book value: the value of an asset calculated with a

Book Value • Book value: the value of an asset calculated with a depreciation model for accounting purposes. – This value may be different from the market value. – There may be several book values given for the same asset, depending on the purpose. e. g. for taxation vs. shareholder reports. • The historical cost of the asset is commonly used as its initial book value. Copyright © 2006 Pearson Education Canada Inc. 6

Value of an Asset • Other terminology: • Salvage Value: either the actual or

Value of an Asset • Other terminology: • Salvage Value: either the actual or estimated value of an asset at the end of its useful life (i. e. when it is sold). • Scrap value: A special case of Salvage Value. Either the actual or estimated value of an asset at the end of its physical life (when it is broken up for parts, or sold to a recycler). Copyright © 2006 Pearson Education Canada Inc. 7

Why Estimate Asset Values? • We need to estimate the value of an asset

Why Estimate Asset Values? • We need to estimate the value of an asset for a variety of reasons: • Making managerial decisions: we need to know asset values. e. g. , for negotiating a loan. • Planning purposes: e. g. asset replacement decisions. • Complying with Tax regulations: The Canadian Government regulates how much depreciation can be claimed on assets. Copyright © 2006 Pearson Education Canada Inc. 8

Depreciation Models • To match the way in which assets depreciate and to meet

Depreciation Models • To match the way in which assets depreciate and to meet regulatory requirements, several depreciation models have been developed. • Two of the most common in Canada are: Straight line depreciation – simple, easy to calculate; Declining balance depreciation - required by Canadian tax laws. • • Copyright © 2006 Pearson Education Canada Inc. 9

6. 2. 3 Straight Line Depreciation • Straight line depreciation (SLD) assumes that the

6. 2. 3 Straight Line Depreciation • Straight line depreciation (SLD) assumes that the rate of loss of an asset’s value is constant over its useful life. – i. e. the value of an asset is linearly decreasing over its useful life. P = purchase price S = salvage value at the end of N periods. N = useful life of asset Copyright © 2006 Pearson Education Canada Inc. 10

Straight Line Depreciation (con’t) Copyright © 2006 Pearson Education Canada Inc. 11

Straight Line Depreciation (con’t) Copyright © 2006 Pearson Education Canada Inc. 11

Straight Line Depreciation (con’t) • Depreciation in period n using SLD: • Book value

Straight Line Depreciation (con’t) • Depreciation in period n using SLD: • Book value of the asset at the end of period n: • Accumulated Depreciation at the end of period n: Copyright © 2006 Pearson Education Canada Inc. 12

Example 6 -1: (important) • An asset was purchased 7 years ago for $10

Example 6 -1: (important) • An asset was purchased 7 years ago for $10 000. It was estimated to have a 10 year service life and a salvage value of $2000 at the end of its service life. • If SLD is a good model of asset value, what its book value today? Copyright © 2006 Pearson Education Canada Inc. 13

Example 6 -1: Answer • Given : n = 7, P = $10 000,

Example 6 -1: Answer • Given : n = 7, P = $10 000, N = 10, S = $2000 • SLD estimates the book value of the asset at $4400 Copyright © 2006 Pearson Education Canada Inc. 14

Comments on the Straight Line Depreciation Method: • SLD’s advantage is that it is

Comments on the Straight Line Depreciation Method: • SLD’s advantage is that it is easy to calculate and understand. • The main problem with SLD is that many assets do not, in fact, depreciate at a constant rate. • Thus, market values often differ from book values when SLD is used. Copyright © 2006 Pearson Education Canada Inc. 15

6. 2. 4 Declining Balance Depreciation • The declining balance method of depreciation models

6. 2. 4 Declining Balance Depreciation • The declining balance method of depreciation models the loss in value of an asset in a period as a constant proportion of the asset’s current value. • DBD often matches the decline in value of an asset well. • DBD must be used for reporting depreciation expenses under Canadian Tax law. Copyright © 2006 Pearson Education Canada Inc. 16

Declining Balance Depreciation Copyright © 2006 Pearson Education Canada Inc. 17

Declining Balance Depreciation Copyright © 2006 Pearson Education Canada Inc. 17

Declining Balance Depreciation • • d = depreciation rate P = purchase price •

Declining Balance Depreciation • • d = depreciation rate P = purchase price • Initial book value: • Book value at the end of period n using DBD • Depreciation in period n using DBD Copyright © 2006 Pearson Education Canada Inc. 18

Example 6 -2 • A new press brake costs Medicine Hat Steel $780 000.

Example 6 -2 • A new press brake costs Medicine Hat Steel $780 000. It is expected to last 20 years, with a $60 000 salvage value. • What rate of depreciation for the decliningbalance method will produce a book value after 20 years that equals the salvage value of the press? Copyright © 2006 Pearson Education Canada Inc. 19

Example 6 -2: Answer • P = $780 000, N = 20 years, S

Example 6 -2: Answer • P = $780 000, N = 20 years, S = $60 000 780 000(1 – d)20 = 60 000 (1 – d)20 = 1/13 d = 1 – (1/13)1/20 = 1 – 0. 8796 = 0. 1204 • A depreciation rate of about 12% will produce a book value in 20 years equal to the salvage value of the press. Copyright © 2006 Pearson Education Canada Inc. 20

Example 6 -3 • An asset was purchased 7 years ago for $10000. It

Example 6 -3 • An asset was purchased 7 years ago for $10000. It was estimated to have a 10 year service life and a salvage value of $2000 at the end of its service life. • If the value of the asset is believed to be depreciating at a constant rate each year, what is its book value today if depreciation is calculated using the Declining Balance Method (DBD)? Copyright © 2006 Pearson Education Canada Inc. 21

Example 6 -3: Answer BVdb(n) = P(1 -d)n BVdb(10) = 10, 000(1 -d)10 =

Example 6 -3: Answer BVdb(n) = P(1 -d)n BVdb(10) = 10, 000(1 -d)10 = S S = 10, 000(1 -d)10 2000 = 10, 000(1 -d)10 d = 1 - (2000/10000)1/10 d = 0. 1487 or 14. 87% (approx) At the end of 7 years: BVdb(7) = 10, 000(1 -. 1487)7 BVdb(7) = $3240 (approx) Copyright © 2006 Pearson Education Canada Inc. 22

Summary • Depreciation and Depreciation Accounting – Reasons for Depreciation – Value of an

Summary • Depreciation and Depreciation Accounting – Reasons for Depreciation – Value of an Asset – Straight Line Depreciation – Declining Balance Depreciation Copyright © 2006 Pearson Education Canada Inc. 23

Depreciation and Income Taxes Asset Depreciation Book DepreciationDepreciation and Income Taxes Asset Depreciation Book Depreciation
DEPRECIATION 1 DEPRECIATION CONCEPT AND DEFINITION OF DEPRECIATIONDEPRECIATION 1 DEPRECIATION CONCEPT AND DEFINITION OF DEPRECIATION
Closing Depreciation Concept Closing Depreciation Closing Depreciation StepClosing Depreciation Concept Closing Depreciation Closing Depreciation Step
DEPRECIATION ACCOUNTING Depreciation is an expenses and notDEPRECIATION ACCOUNTING Depreciation is an expenses and not
Depreciation and Depreciation Accounting Copyright 2006 Pearson EducationDepreciation and Depreciation Accounting Copyright 2006 Pearson Education
Depreciation 2 Accounting entries Once depreciation has beenDepreciation 2 Accounting entries Once depreciation has been
Depreciation Accounting Definition Depreciation is a measure ofDepreciation Accounting Definition Depreciation is a measure of
PROFIT AND GAINSII DEPRECIATION INTRODUCTION Depreciation is aPROFIT AND GAINSII DEPRECIATION INTRODUCTION Depreciation is a
Appreciation and Depreciation Appreciation and Depreciation Appreciation refersAppreciation and Depreciation Appreciation and Depreciation Appreciation refers
DEPRECIATION PROVISIONS AND RESERVES 1 CONCEPT OF DEPRECIATIONDEPRECIATION PROVISIONS AND RESERVES 1 CONCEPT OF DEPRECIATION
Taxes and Depreciation MACRS Review What is DepreciationTaxes and Depreciation MACRS Review What is Depreciation
Accounting Standard6 DEPRECIATION ACCOUNTING Presented by Subodh JainAccounting Standard6 DEPRECIATION ACCOUNTING Presented by Subodh Jain
DEPRECIATION ASSET VALUATION 1 21 10 DEPRECIATION WhatDEPRECIATION ASSET VALUATION 1 21 10 DEPRECIATION What
Creating Pending Depreciation Transactions Concept Creating Pending DepreciationCreating Pending Depreciation Transactions Concept Creating Pending Depreciation
Depreciation Our purpose in studying depreciation is toDepreciation Our purpose in studying depreciation is to
Understanding UserDefined Depreciation Concept Understanding UserDefined Depreciation UnderstandingUnderstanding UserDefined Depreciation Concept Understanding UserDefined Depreciation Understanding
Depreciation Definition n HKSSAP defines depreciation as theDepreciation Definition n HKSSAP defines depreciation as the
Chapter 3 Part 2 Depreciation Depreciation loss ofChapter 3 Part 2 Depreciation Depreciation loss of
DEPRECIATION Section Advanced Agribusiness Unit Depreciation Lesson TitlesDEPRECIATION Section Advanced Agribusiness Unit Depreciation Lesson Titles
DEPRECIATION T Madas Depreciation is the loss inDEPRECIATION T Madas Depreciation is the loss in
Depreciation Chapter Outline What is depreciation Why needDepreciation Chapter Outline What is depreciation Why need
Depreciation The depreciation expense used for capital budgetingDepreciation The depreciation expense used for capital budgeting