Chapter Overview

Depreciation may be determined for internal company records (book depreciation) or for income tax purposes (tax depreciation). In the U.S., the MACRS method is the only one allowed for tax depreciation. Depreciation does not result in actual cash flow directly. It is a book method by which the capital investment in tangible property is recovered. The annual depreciation amount is tax deductible, which can result in actual cash flow changes.

Some important points about the straight line, declining balance, and MACRS models are presented below. Common relations for each method are summarized in Table 16–5.

• It writes off capital investment linearly over n years.
• The estimated salvage value is always considered.
• This is the classical, nonaccelerated depreciation model.

• The model accelerates depreciation compared to straight line.
• The book value is reduced each year by a fixed percentage.
• The most used rate is twice the SL rate, which is called double declining balance (DDB).
• It has an implied salvage that may be lower than the estimated salvage.
• It is not an approved tax depreciation method in the U.S. It is frequently used for book depreciation purposes.

• It is the only approved tax depreciation system in the United States.
• It automatically switches from DDB or DB to SL depreciation.
• It always depreciates to zero; that is, it assumes S = 0.
• Recovery periods are specified by property classes.
• Depreciation rates are tabulated.
• The actual recovery period is 1 year longer due to the imposed half-year convention.
• MACRS straight line depreciation is an option, but recovery periods are longer than for regular MACRS.

Cost and percentage depletion methods recover investment in natural resources. The annual cost depletion factor is applied to the amount of resource removed. No more than the initial investment can be recovered with cost depletion. Percentage depletion, which can recover more than the initial investment, reduces the investment value by a constant percentage of gross income each year.

<a onClick="window.open('/olcweb/cgi/pluginpop.cgi?it=gif::Table 16-5::/sites/dl/free/0072432349/22722/table_1605.gif','popWin', 'width=NaN,height=NaN,resizable,scrollbars');" href="#"><img valign="absmiddle" height="16" width="16" border="0" src="/olcweb/styles/shared/linkicons/image.gif">Table 16-5 (5.0K)</a>Table 16-5