Depreciation

ENGR 301 Lecture 21

Economic The gradual decrease in Utility in an asset with Use and time

Depreciation 2 Physical

Accounting The systematic allocation Of an asset’s value in Portions over its Depreciable life – often Used in engineering Economics analysis

Functional book

S. El-Omari

ENGR 301 Lecture 21

S. El-Omari

Accounting Depreciation Methods Two different ways of calculating depreciation: 1. Book depreciation method. Intended for financial report such as for the balance sheet or income statement. Depreciation represent the actual loss in value of the asset

2. Capital Cost Allowance (CCA) For the Canada Customs and Revenue Agency for the purpose of calculating taxes. The asset is depreciated quickly at the beginning of its life so company could benefit at the beginning of their business not to pay higher income tax. S. El-Omari

ENGR 301 Lecture 21

Tax

ENGR 301 Lecture 21

Book Depreciation Three deferent methods for book depreciation • Straight line method. • Accelerated method. 1. Declining balance method. Also Double Declining Balance 2. Sum-of-year’s-digits method.

S. El-Omari

Straight Line Method (SL)

ENGR 301 Lecture 21

Accelerated Methods

Straight line method of depreciation interprets a fixed asset as one that provides its services in uniform fashion. ( P − S) Dn = N Dn = Depreciation charge during year n P = Cost of the asset including installation charges S = Salvage value at the end of useful life N = Useful life

Accelerated method recognizes that the stream service provided by a fixed asset decrease over time. The reason is that the mechanical efficiency of an asset tends to decline with age. Two methods: 1. Declining / double declining balance method. 2. Sum-of-year’s-digits method.

S. El-Omari

S. El-Omari

ENGR 301 Lecture 21

ENGR 301 Lecture 21

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Declining Balance Method (DB) D1 = dP

d=

1 N

Double Declining Balance Method (DDB) Declining Balance depreciation (DB) = dP

D2 = d ( P − D1 ) = dP(1 − d )

Dn = dP(1 − d )

n−1

d=

,n ≥ 1

1 N

Total Declining Balance depreciation (TDB) = Double Declining Balance depreciation (DDB) = 2dP TDBn = D1 + D2 + ......+ Dn

[

n TDBn = P 1 − (1 − d )

] n Bn = P(1 − d )

Bn = P − TDBn

S. El-Omari

ENGR 301 Lecture 21

S. El-Omari

Sum-of-Year’s Digits (SOYD) SOYD results in larger depreciation charges during the early years and unlike the DB it guarantees that Bn = S automatically.

N ( N + 1) SOYD = 1 + 2 + 3+ ....+ N = 2

Dn = S. El-Omari

ENGR 301 Lecture 21

Capital Cost Allowance Book depreciation term

Tax depreciation term

Asset

Property

Depreciation

Capital cost allowance (CCA)

Cost basis

Capital cost

Book value

Undepreciated capital cost

Salvage value

Proceeds of disposition

N − n+1 ( P − S) SOYD ENGR 301 Lecture 21

S. El-Omari

ENGR 301 Lecture 21

S. El-Omari

ENGR 301 Lecture 21

Capital Cost Allowance Deference between book depreciation and CCA 1. The income tax act specifies exactly how the CCA must be calculated. 2. Most property items are not depreciated individually, but are grouped into classes (decided by the government). As they would have comparable usage characteristics and life times. Ex. Building in class 3 last longer than those in class 6 S. El-Omari

ENGR 301 Lecture 21

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Available-for-Use Rule Property can be ready to claim CCA only when it’s available-for-use. A property is considered availablefor-use on the earliest of the following dates: 1. When the property is first used to produce income. 2. When the business can use the property to produce saleable product or perform saleable service. 3. The beginning of the first taxation year that starts at least 358 days after the taxation year during which the corporation acquired the property. 4. Immediately before disposal the property. S. El-Omari

ENGR 301 Lecture 21

The 50% Rule Introduced to limit the maximum CCA of property acquired during the year to 50%. Introduced in 1981 Applied for property purchased near the end of the year. Most, but not all, depreciable property is subject to the 50% rule.

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ENGR 301 Lecture 21

Calculating CCA • To claim CCA, a firm must fill out a schedule 8 form.

EX. •Any tax credit or rebate Received in the year •Government assistance received in the current year

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ENGR 301 Lecture 21

S. El-Omari

ENGR 301 Lecture 21

S. El-Omari

ENGR 301 Lecture 21

= column 6 in case salvage > Than undepreciated cost

Calculating CCA Example:

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ENGR 301 Lecture 21

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