Depreciation is the decrease in the value of assets with the passage of
time. An asset has value because one can expect to receive future monetary benefits through its possession and use.
Benefits of Depreciation
The benefits are in the form of future cash flows resulting from the use of the asset to
produce salable goods and services and the ultimate sale of the asset.
The following methods of depreciation are discussed:
- Straight Line (SL) Method
- Declining/Diminishing Balance (DB) Method
- Sinking Fund Method
- Sum of the Year Digit (SOYD) Method
- MACRS Method
It assumes that the loss in value is directly proportional to the age of
The annual depreciation is a fixed (or constant or uniform or equal) amount throughout the lifetime of the asset such that the accumulated sum at the end of the life is exactly equal to the purchase price or value of the asset.
Sinking Fund Method
The sinking Fund Method assumes that a sinking fund is established in which funds will accumulate for replacement purposes.
The total depreciation that has taken place up to any given time is assumed to
be equal to the accumulated value of the sinking fund (including interest earned) at that time.
With this method, I, N, S, and I on the sinking fund (I – S) are known, and a
uniform yearly deposit can be computed. the cost of depreciation for
a year is the sum of this deposit and accumulated interest for that
Sum of the Year Digit (SYD)
The Sum of the Year Digit (SYD) Method enables properties to be depreciated to zero value and is easier to use than the declining balance (DB) method.
The use of the SYD method permits very rapidly (accelerated) depreciation during the earlier period of life. In effect reduces the computed profits during the early years of asset life and thus reduces income taxes in those early years.
To compute the depreciation deduction by the SYD method, the digits corresponding to the number of each permissible year of life are first listed in reverse order. The sum of these digits is then determined. The depreciation factor for any year is the number from the reverse-ordered listing for that year divided by the sum of the digits.
Minimum Attractive Rate of Returns (MACRS)
MACRS uses switching from declining balance (DB) to Straight line (SL) the method with a half-year convention. i.e. all the assets are placed in service at mid-year and they have zero salvage value. i.e. only half-year depreciation is allowed for the 1st year, full-year depreciation and the remaining half-year depreciation in the year following the end of the recovery period.
MACRS method includes 8 categories of assets:
- 3- year property includes special material handling devices and special tools for manufacturing.
- 5-year property includes automobiles, light and heavy trucks, computers, copiers, semiconductor manufacturing equipment, qualified technological equipment, and equipment used in research.
- The 7-year property includes property that is not assigned to another class, such as office furniture, fixtures, single-purpose agricultural structures, and a railroad track.The
- 10-year property includes assets used in petroleum refining, and in the manufacture of castings, forgings, vessels, barges, and tugs.The
- 15-year property includes service station buildings, telephone distribution equipment, and municipal water and sewage treatment plant.The
- 20-year property includes farm buildings and municipal sewers
For real property:
- The 27.5-year property includes residential property: an apartment building
and rental houses.
- The 39-year property includes non-residential buildings; warehouses,
manufacturing facilities, refineries, mills, parking facilities, fences, and
1. What is Basis or Cost Basis or Unadjusted Cost Basis?
The initial or original cost of acquiring an asset (purchase price plus sales tax) including transportation cost and other normal costs of making the asset serviceable for its intended use.
2. What does the depreciation represent?
Therefore depreciation represents and estimates of decrease in the value of an asset because its ability to produce future cash flows will, most
likely decrease over time.