Minggu 9 Chapter 11 Depreciation and Capital Allowances - 12e XE - REV

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ENGINEERING
Newnan, Lavelle, and Eschenbach
ECONOMIC
ANALYSIS, 12/e Copyright © 2014 by Oxford University Press
Chapter 11
Depreciation
Copyright Oxford University Press 2014

Chapter Outline
• Basic Aspects of Depreciation

• Historical Depreciation Methods
• Modified Accelerated Cost Recovery
System (MACRS)
• Depreciation and Asset Disposal
• Unit-of-Production Depreciation
• Depletion
• Spreadsheets and Depreciation

Learning Objectives
• Understand the concepts of depreciation,

deterioration, and obsolescence
• Use historical and MACRS to calculate annual
depreciation charge and book value over the asset’s
life
• Account for capital gains/losses, ordinary losses,
and depreciation recapture due to the disposal of a
depreciated asset
• Use unit-of-production and depletion depreciation
methods in economic analysis
• Use spreadsheets to calculate depreciation

Income, Depreciation,
and Cash Flow
• Sales of products
Revenue • Charges for services
• Cost of Goods Sold
• Labor wages, Materials, Utilities,
Machines (depreciation), Factory
buildings (depreciation)
• Selling Costs
Costs • Advertising, Sale commissions
• Administration Costs
• Administrative salaries, Office rental
• Financial Costs
• Interest paid on debt
Basic Aspects of Depreciation
• An important component in computing
income taxes.
• For tax purposes:
Depreciation is the systematic

allocation of the cost of an asset
spread over its depreciable life.
6
Basic Aspects of Depreciation
DEFINITION: A DECREASE IN VALUE

In Economic Context:
• Decline in market value of an asset due to
deterioration or obsolescence
• Decline in value of an asset to its owner
In Accounting Context:
• Systematic allocation of an asset’s cost over its
useful or depreciable life. Depreciable life is
related to
– Deterioration
– Obsolescence
Depreciation and Expenses
Expenses:
• Part of regular business operations
• “Consumed” over short period of time
• Sometimes recurring
• Do not lose value gradually over time
• Subtracted from business revenues as they
occur
• Reduce income taxes as they can be written off
when they occur
• Examples: labor, utilities, materials, insurance,…

Depreciation and Expenses
Depreciation:
• Business costs due to capital assets are not fully
written off when they occur
• Capital assets lose value gradually over time
• Capital cost must be written off or depreciated
over its depreciable life or recovery period
• Reduce the taxable income, and thus reduce
income taxes as they were written off
• It is a non-cash cost
• Examples: building, plants, machines,…

Basic Requirements for
Depreciation
A Property is Depreciable If:
• The property must be used for business purposes
to produce income.
• The property must have a useful life that can be
determined, and the useful life must be longer than
one year.
• The property must be an asset that decays, gets
used up, wears out, becomes obsolete, or loses
value to the owner from natural causes.
Only the owner of property may claim depreciation
expenses

Types of Property
Tangible property: can be seen, touched, and felt.

• Real property: land, buildings, and things growing
on, built upon, constructed on, or attached to the land
• Personal property: equipment, furnishings, vehicles,
office machinery, and anything that is tangible
excluding real property
Intangible property: has value but cannot be
directly seen or touched, examples include
patents, copyrights, and trademarks, trade
names, and franchises.

Property and Depreciation
• Almost all tangible property can be depreciated

except land, factory inventory, containers
considered as inventory, and leased property.
• Tangible property used in both business and
personal activities can be depreciated, but only in
proportion to the use for business purposes.
• Intangible property can generally be depreciated.
In general buildings and
equipment are depreciable;
land is not.
Example 12-1 Taxable Income
Actual cash flows:
Year 1 Year 2 Year 3
Gross income $200 $200 $200
Purchase of special tooling -60 0 0
All other expenditures -140 -140 -140
Cash flows for the year $0 $60 $60
Taxable Income:
Year 1 Year 2 Year 3
Gross income $200 $200 $200
All other expenditures -140 -140 -140
Depreciation charges -20 -20 -20
Cash flows for the year $40 $40 $40

Depreciation Calculation
Fundamentals
Book value = Cost basis − Depreciation charges made to date
𝑡𝑡
𝐵𝐵𝐵𝐵𝑡𝑡 = 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏𝑏 − � 𝑑𝑑𝑗𝑗 (11-1)
B
𝑗𝑗=1
𝐵𝐵𝐵𝐵𝑡𝑡 = Book value at the end of time t Total
Depreciation
Book Value
Cost basis = 𝐵𝐵 = Dollar amount being Charges
depreciated including the asset’s Curve values depend
purchase price and any other On depreciation method
costs necessary to make the asset
“ready to use” Salvage value
S
𝐷𝐷𝑗𝑗 = Depreciation deduction in year 𝑗𝑗
Depreciable Life
∑ 𝐷𝐷𝑗𝑗 = Accumulated depreciation
charges from time 1 to 𝑗𝑗

Time-based Depreciation Methods
Pre-1981 classic methods:

• Straight-line (SL)
• Sum-of-the-years’-digits (SOYD)
• Declining balance (DB)
• required estimates of useful life and salvage value
1981-1986 method:
• Accelerated Cost Recovery System (ACRS)
• Property class lives were created
• Salvage value was ignored
• Shorter recovery periods were used
1986-present:
• Modified Accelerated Cost Recovery System (MACRS)
• Number of property classes was expanded
• Half-year convention for the first and final years

Classic Depreciation Methods
Straight-line (SL)
𝐵𝐵 − 𝑆𝑆 (11-2)
𝑑𝑑𝑡𝑡 = where
𝑁𝑁 𝑑𝑑𝑡𝑡 = Depreciation charge in
Sum-of-the-years’-digits (SOYD) year 𝑡𝑡
𝑁𝑁−𝑡𝑡+1 𝐵𝐵 = Cost of the asset made
𝑑𝑑𝑡𝑡 = (B – S) (11-3)
𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 ready for use
𝑆𝑆 = Estimated salvage value
Double declining balance (DDB) after depreciable life
2 𝑁𝑁 = Number of years in
𝑑𝑑𝑡𝑡 = 𝐵𝐵𝐵𝐵𝑡𝑡−1 (11-4) depreciable life
𝑁𝑁 𝑆𝑆𝑆𝑆𝑆𝑆𝑆𝑆 = Sum of years’ digits
2 𝑡𝑡−1
= (𝐵𝐵 − � 𝑑𝑑𝑗𝑗 ) = 𝑁𝑁(𝑁𝑁 + 1)/2
𝑁𝑁 𝑗𝑗=1

Example 11-2 SL Depreciation
Cost of the asset, 𝐵𝐵 $900

Depreciable life, in years, 𝑁𝑁 5
Salvage value, 𝑆𝑆 $70
900
800 166
𝑑𝑑𝑡𝑡 ∑𝑑𝑑𝑡𝑡 𝐵𝐵𝐵𝐵 700
Year 166
($1,000) ($1000) ($1000) 600
Book Value
500
0 900 166
400
1 166 166 734 166
300
2 166 332 568 200
3 166 498 402 100 Salvage value
166
4 166 664 236 0
5 166 830 70 0 1 2 3 4 5
Year

Accelerated Depreciation
• The rest of the methods discussed are called
“Accelerated Depreciation” methods.
• These methods deduct larger depreciation
expenses in the early years and less at the end.
• The large early deductions result in tax savings
that are realized sooner.
• A basic principle of the time value of money:
“Money now is better than money later”
18
Sum-of-Years-Digits (SOYD)
19
Example 11-3 SOYD Depreciation
900.00
𝑑𝑑𝑡𝑡 ∑𝑑𝑑𝑡𝑡 𝐵𝐵𝐵𝐵 800.00
Year 277
($1,000) ($1000) ($1000) 700.00
0 $900.00 600.00
Book Value
221
1 $276.67 $276.67 623.33 500.00
400.00
2 221.33 498.00 402.00 166
300.00
3 166.00 664.00 236.00
200.00 111
4 110.67 774.67 125.33 100.00 Salvage value 55
5 55.33 830.00 70.00 0.00
0 1 2 3 4 5
Year

Double Declining Balance (DDB)
21
Example 11-4 DDB Depreciation
900.00
800.00
𝑑𝑑𝑡𝑡 ∑𝑑𝑑𝑡𝑡 𝐵𝐵𝐵𝐵 700.00
360
Year
($1,000) ($1000) ($1000) 600.00
Book Value
0 900.00 500.00 216
400.00
1 360.00 360.00 540.00
300.00
2 216.00 576.00 324.00 130
200.00 78
3 129.60 705.60 194.40 100.00 Salvage value 47
4 77.76 783.36 116.64 0.00
5 46.66 830.02 69.98 0 1 2 3 4 5
Year

DDB With Conversion to SL
at the Most Desirable Time
• Since DDB does not use a value for Salvage, we
have three possible scenarios at time of disposal:
– Over depreciation: Book Value < Salvage Value. Tax
savings realized early. Small gain upon sale of the
asset and taxes on the gain.
– Exact depreciation: Book value = Salvage value.
There are no tax consequences upon sale of the asset.
– Under depreciation: Book Value > Salvage Value.
Did not deduct as much as you could have and lost tax
savings.
• To allow companies the advantage of all the depreciation
charges they are entitled to, they can switch from DDB to
straight line at the most favorable time.
23
DDB Is the Preferred Approach
• Using the DDB approach provides the
greatest PW (tax savings).
• The DDB approach does not fully
depreciate an item unless a switch to
straight line is accomplished in the latter
years.
• The question is which is the most
advantageous year to switch to SL.
24
Example of DDB with Conversion to
SL
• Same example, except that the Salvage Value is $ 30
instead of $ 70
• Year Depreciation Book value at the
end of year
1 $ 360 $ 540
2 $ 216 $ 324
3 $ 129,6 $ 194,4
4 $ 77,76 $ 116,64
5 $ 46,656 $ 69,984
25
Declining Balance depreciation with conversion
to Straight-Line depreciation
• If we convert to the straight line at year :

Straight line Declining Balance Decision
540 − 30
2 = $127,5 < $216 Do not convert
4
to straight line
324 − 30
3 = $98 < $129,6 Do not convert
3 to straight line
194,4 − 30 > $ 77,76 Convert to straight

4 = $82,2
2 line for year
4
Declining Balance depreciation with conversion
to Straight-Line depreciation
• Conclusion :
The depreciation charge with declining
balance depreciation with conversion to
straight line depreciation are :
Year Depreciation charge
1 $ 360
2 $ 216
3 $ 129,6
4 $ 82,2
5 $ 82,2
Advantages of Modified Accelerated
Cost Recovery System
• “Property class lives” are less than the “actual
useful lives”
• Definition of MACRS classes of depreciable property is
based on the guideline of the asset depreciable range
(ADR)
• With ADR, each class of property has a lower limit, a
midpoint, and a upper limit of useful life
• The ADR midpoint lives were somewhat shorter than the
actual average useful lives
• MACRS property class lives are shorter than the ADR
midpoint lives
• Salvage value was assumed to be 0
• Tables of annual percentages simplify computations

Modified Accelerated Cost
Recovery System (MACRS)
• General Depreciation System (GDS)
• Based on declining balance with switch to straight-line
depreciation
• Alternative Depreciation System (ADS)
• ADS provides a longer recovery period and uses straight-
line depreciation
• ADS must be used for
• Tangible property used primarily outside the United States
• Property that is tax exempt or financed by tax-exempt bonds
• Farming property placed in service when uniform capitalization
rules are not applied
• ADS may be elected for an asset, it is not possible to
switch back to the GDS.
Procedures in Applying
MACRS-GDS Depreciation
1. Determine if a property is eligible for depreciation
2. Determine the asset’s cost basis (𝐵𝐵)
• Cost to obtain and place the asset in service fit for use
• For real property, the basis may include certain fees and
charges, such as legal and recording fees, abstract fees,
survey charges, transfer taxes, title insurance, …
3. Determine the property class and recovery period
• Use property class given in problem
• Match asset name with MACRS-GDS property classes
definition (Table 11-2)
• Use IRS publication, such as Table 11-1
• Use ADR class life to determine property class
Applying
MACRS-GDS Depreciation
𝑑𝑑𝑡𝑡 = 𝐵𝐵 × 𝑟𝑟𝑡𝑡 (11-5)
where
𝑑𝑑𝑡𝑡 = Depreciation charge in year 𝑡𝑡
𝐵𝐵 = Cost basis
𝑟𝑟𝑡𝑡 = Appropriate MACRS percentage rate

Table 11-1 Example Class Lives
and MACRS Property Classes
IRS Class Life MACRS Property
Asset Asset Description (Years) Class (years)
Class ADR GDS ADS
00.11 Office furniture, fixtures, and equipment 10 7 10
00.12 Information Systems: computer/peripheral 6 5 6
00.22 Automobiles, taxis 3 5 5
00.241 Light general-purpose trucks 4 5 5
00.25 Railroad cars and locomotives 15 7 15
00.40 Industrial steam and electric distribution 22 15 22
01.11 Cotton gin assets 12 7 12
01.21 Cattle, breeding or dairy 7 5 7
13.00 Offshore drilling assets 7.5 5 7.5
13.30 Petroleum refining assets 16 10 16
15.00 Construction assets 6 5 6

Table 11-1 Example Class Lives
and MACRS Property Classes
IRS Class Life MACRS Property
Asset Asset Description (Years) Class (years)
Class ADR GDS ADS
21.10 Manufacture of grain and grain mill products 17 10 17
22.2 Manufacture of yarn, thread, and woven fabric 11 7 11
24.10 Cutting of timber 6 5 6
32.20 Manufacture of cement 20 15 20
37.11 Manufacture of motor vehicles 12 7 12
48.11 Telephone Communications assets and buildings 24 15 24
48.2 Radio and television broadcasting equipment 6 5 6
49.12 Electric utility nuclear production plant 20 15 20
49.13 Electric utility steam production plant 28 20 28
49.23 Natural gas production plant 14 7 14
50.00 Municipal wastewater treatment plant 24 15 24
80.00 Theme and amusement park assets 12.5 7 12.5

Table 11-2
MACRS GDS Property Classes
Property Class Personal Property (all property except real estate)
3-Year Property • Special handling devices for food and beverage manufacture
• Special tools for the manufacture of finished plastic products, fabricated
metal products, and motor vehicles
• Property with ADR class life of 4 years or less
5-Year Property • Automobiles and trucks (The depreciation for automobiles is limited to
$2960 the first tax year, $4700 the second year, $2850 the third year, and
1675 per year in subsequent years.)
• Aircraft (of non-air-transport companies)
• Equipment used in research and experimentation
• Computers
• Petroleum drilling equipment
• Property with ADR class life of more than 4 years and less than 10 years
7-Year Property • All other property not assigned to another class
• Office furniture, fixtures, and equipment
• Property with ADR class life of 10 years or more and less than 16 years

Table 11-2
MACRS GDS Property Classes
Property Class Personal Property (all property except real estate)
10-Year Property • Assets used in petroleum refining and certain food products
• Vessels and water transportation equipment
15-Year Property • Telephone distribution plants
• Municipal sewage treatment plants
20-Year Property • Municipal sewers
• Property with ADR class life of 25 years or more
Property Class Real Property (real estate)
27.5 Year Residential rental property (does not include hotels and motels)
39 Years Nonresidential real property

Table 11-3
MACRS GDS Percentage Rate
Recovery 3-year 5-year 7-year 10-year 15-year 20-year
Year class class class class class class
1 33.33 20.00 14.29 10.00 5.00 3.750
2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.81* 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52* 12.49 11.52 7.70 6.177
5 11.52 8.93* 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55* 5.90* 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462*
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12-15 5.90 4.461
16 2.95 4.461
17-20 4.462
21 2.231

Calculation of
MACRS GDS Percentages
1. The 3-, 5-, 7-, and 10-year classes use 200% and the 15-
and 20-year classes use 150% declining balance
depreciation.
2. All classes convert to straight-line depreciation in the
optimal year, shown with the asterisk (*).
3. A half-year of depreciation is allowed in the first and last
recovery years.
4. Salvage value are assumed to be zero for all assets.

Table 11-4
MACRS GDS Percentage Rate
Residential Rental Property
Recovery
Year Month placed in service
1 2 3 4 5 6 7 8 9 10 11 12
1 3.485 3.182 2.879 2.576 2.273 1.970 1.667 1.364 1.061 0.758 0.455 0.152
2-27 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636 3.636
28 1.970 2.273 2.576 2.879 3.182 3.485 3.636 3.636 3.636 3.636 3.636 3.636
29 0.152 0.455 0.758 1.061 1.364 1.667
Nonresidential Real Property
Recovery
Year Month placed in service
1 2 3 4 5 6 7 8 9 10 11 12
1 2.461 2.247 2.033 1.819 1.605 1.391 1.177 0.963 0.749 0.535 0.321 0.107
2-39 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564 2.564
40 0.107 0.321 0.535 0.749 0.963 1.177 1.391 1.605 1.819 2.033 2.247 2.461

Example 11-5 Calculation of
MACRS GDS Percentages
The 5-year class uses 200% declining balance depreciation
with conversion to straight-line depreciation. B=100%, S=0,
half-year for the 1st and last of recovery period
MACRS Book
Year DDB Calculation SL Calculation Rates Value
0 100.00%
1 (½)(2/5)(100%)=20.00% (½)(100%/5)=10.00% 20.00% 80.00%
2 (2/5)(80.00%)=32.00% (80.00%/4.5)=17.78% 32.00% 48.00%
3 (2/5)(48.00%)=19.20% (48.00%/3.5)=13.71% 19.20% 28.80%
4 (2/5)(28.80%)=11.52% (28.80%/2.5)=11.52% 11.52% 17.28%
5 11.52% 11.52% 5.76%
6 (½)11.52%=5.76% 5.76% 0.00%

MACRS GDS Depreciation
7-year property class, B=$150000, S=$30000
MACRS
Year MACRS, 𝑟𝑟t MACRS Calculation Depreciation, 𝑑𝑑 t Book Value
0 $150,000
1 14.29% ($150000)(14.29%) $21,435 128,565
2 24.49% (150000)(24.49%) 36,735 91,830
3 17.49% (150000)(17.49%) 26,235 65,595
4 12.49% (150000)(12.49%) 18,735 46,860
5 8.93% (150000)(8.93%) 13,395 33,465
6 8.92% (150000)(8.92%) 13,380 20,085
7 8.93% (150000)(8.93%) 13,395 6,690
8 4.46% (150000)(4.46%) 6,690 0

MACRS GDS Depreciation
39-year property class, B=$20,000,000, purchased in April,
disposed 5 years later in August.
MACRS, MACRS
Year 𝑟𝑟𝑡𝑡 MACRS Calculation Depreciation, 𝑑𝑑𝑡𝑡 Book Value
0 $20,000,000
1 1.819% ($20000000)(1.819%) $363,800 19,636,200
2 2.564% (20000000)(2.564%) 512,800 19,123,400
3 2.564% (20000000)(2.564 %) 512,800 18,610,600
4 2.564% (20000000)(2.564 %) 512,800 18,097,800
5 2.564% (20000000)(2.564 %) 512,800 17,585,000
6 2.564% (7.5/12)(20000000)(2.564 %) 321,000 17,264,000
2,736,000

Example 11-8 Comparison of
Depreciation Methods
150000
125000
100000
Book Value
SL
75000
SOYD
50000
MACRS
25000 DDB
0
0 1 2 3 4 5 6 7 8 9 10
Year

Depreciation and Asset Disposal
When a depreciable asset is disposed of, and the market

value is different than the book value, the difference must
be treated as:
• Depreciation recapture (ordinary gains): Depreciation
recapture occurs when an asset is sold for more than its
current book value, but less than the original cost basis.
• Losses: A loss occurs when an asset is sold for less than
its current book value.
• Capital gains: Capital gain occur when an asset is sold for
more than its original cost basis. Capital gains may be
taxed at lower rate than ordinary gains.

14000 14000 14000
$4000
12000 12000 12000 Capital
Gain
10000 $2000 10000 10000
Depreciation
8000 Recapture 8000 8000 $5000
$3000 Depreciation
6000 6000 Loss 6000 Recapture
4000 4000 4000
2000 2000 2000
0 0 0
Cost Market Book Cost Market Book Cost Market Book
Basis Value Value Basis Value Value Basis Value Value

Item is sold for more than Book Value -
Ordinary Gain
45
Item is sold for below Book
Value - Ordinary Loss
46
Item sold for more that what was
paid for it-Ordinary & Capital Gain
47
Example 11-9
3-year property class, B=$10000
MACRS
Year MACRS, 𝑟𝑟𝑡𝑡 Depreciation, 𝑑𝑑𝑡𝑡 Book Value Market Value
0 $10,000
1 33.33% $3,333 6,667
2 44.45% 4,445 2,222
3 14.81% 1,481 741
4 7.41% 741 0
5 0 0 0 X
a) If market value = $7000, the recaptured depreciation = $7000

b) If market value = $0, no recaptured depreciation or loss
c) If market value = -$2000, there is a loss of $2000
Example 11-10
1) MACRS
0 $10,000
1 33.33% $3,333 6,667
2 44.45% (1/2)4,445=2,222.5 4,444.5 $5000
Market Value – Book Value = $5000 – 4444.5 = 555.5 (recaptured depreciation)
Total deduction from taxable income = 𝑑𝑑2 − 𝑅𝑅𝑅𝑅𝑅𝑅. 𝑑𝑑𝑑𝑑𝑑𝑑. = 2222.5 − 555.5 = $1667
2)
MACRS
0 $10,000
1 33.33% $3,333 6,667
2 44.45% (0)4,445=0 6,667 $5000
Market Value – Book Value = $5000 – 6667 = -1667 (Loss)

Total deduction from taxable income = $1667

Example 11-10
3) MACRS
0 $10,000
1 33.33% $3,333 6,667
2 44.45% (1)4,445=4445 2,222 $5000
Market Value – Book Value = $5000 – 2222 = 2778 (recaptured depreciation)
Total deduction from taxable income = 𝑑𝑑2 − 𝑅𝑅𝑅𝑅𝑅𝑅. 𝑑𝑑𝑑𝑑𝑑𝑑. = 4445 − 2778 = $1667

Unit-of-Production Depreciation
• Useful when the recovery of depreciation on an asset is

more closely related to use than time
• Not considered an acceptable method for general use
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑡𝑡
𝑑𝑑𝑡𝑡 = (𝐵𝐵 − 𝑆𝑆) (11-6)
∑𝑗𝑗=1 𝑡𝑡𝑡𝑡 𝑁𝑁 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑗𝑗
where
𝑑𝑑𝑡𝑡 = Depreciation charge in year 𝑡𝑡
𝐵𝐵 = Cost basis
𝑆𝑆 = Estimated salvage value after depreciable life
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑡𝑡 = Production for year 𝑡𝑡
∑𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃 = Total lifetime production for asset

Example 11-11
Unit-of-Production Depreciation
5-year depreciable life, B=$900, S=$70
Annual UOP Depreciation UOP Book
Year Production Calculation Depreciation, 𝑑𝑑𝑡𝑡 Value
0 $900
1 4,000 (4,000/40,000)(830) $83 817
2 8,000 (8,000/40,000)(830) 166 651
3 16,000 (16,000/40,000)(830) 332 319
4 8,000 (8,000/40,000)(830) 166 153
5 4,000 (4,000/40,000)(830) 83 70
40,000

Depletion
• Depletion is the exhaustion of natural resources as a result
of their removal.
• Except for standing timber and most oil and gas wells,
depletion allowance is the larger of the two methods.
• Cost Depletion:
• Similar to the unit-of-production depreciation method
• Permissible for standing timber and most oil and gas wells
• Cost of land must be excluded from the property cost
• Percentage Depletion:
• Depletion allowance is a certain percentage of the property’s
gross income during the year
• Cannot exceed 50% of the property’s taxable income
computed without the depletion deduction

Table 11-6
Percentage Depletion Allowance
Type of Deposits Rate
Sulfur, uranium, and, if from deposits in the United States, asbestos, 22%
lead ore, zinc ore, nickel ore, and mica
Gold, silver, copper, iron ore, and certain oil shale, if from deposits in 15%
the United States
Borax, granite, limestone, marble, mollusk shells, potash, slate, 14%
soapstone, and carbon dioxide produced from a well
Coal, lignite, and sodium chloride 10%
Clay and shale used or sold for use in making sewer pipe or bricks or 7½%
used or sold for use as sintered or burned lightweight aggregates
Clay used or sold for making drainage and roofing tile, flower pots, and 5%
kindred products, and gravel, sand, and stone (other than stone
used or sold for use by a mine owner or operator as dimension or
ornamental stone)

Cost Depletion (1)
• The elements of the Depletion calculation:
– Cost of the property
– Estimation of the number of recoverable units (tons of
ore, cubic meters of gravel, barrels of oil, and so forth
– Salvage value of the property
Cost Depletion (2)
• Example :
A small lumber company bought a tract of
timber for $ 35.000 of which $5.000 was the
value of the land and $ 30.000 was the value
of the estimated 1,5 million board-feet of
standing timber. The first year, the company
cut 100.000 boar-feet of standing timber on
the tract. What was the depletion allowance
for the year?
Cost Depletion (3)
• Depletion allowance per 1000 board-feet

of timber
$35000 − $5000
= = $20 per 1000board − feet
1500000 board − feet
• The depletion allowance for the year

would be
= 100000 board-ft x $20 per 1000 board-
ft = $2000
Example 11-12 Cost Depletion
Cost of property (timber) = $35,000

Cost of land = $5000 (included in the cost of property)
Estimated timber production = 1.5 million board-feet
First year’s production = 100,000 board-feet
100,000
𝑑𝑑1 = $35,000 − 5,000 = $2,000
1,500,000

Percentage Depletion (1)
• Percentage depletion is an annual allowance of a percentage of

the gross income from the property.
• Allowable percentage depletion on a property in any year
cannot exceed 50% of the property taxable income computed
without the depletion deduction
• Percentage depletion allowance for selected items:
• Example:
A coal mine has a gross income of $250.000 for the
year. Mining expenses equal $ 210.000. Compute the
allowable percentage depletion deduction !
• Compute percentage depletion :
Gross income from mine
$250000
Percentage depletion x 10%
Computed percentage depletion $ 25000
• Taxable income limitation:
Gross income from mine $250000
less: expenses other than depletion - 210000
Taxable income from mine 40000
Deduction limitation x 50%
Taxable income limitation $ 20000
Since the taxable income limitation ($20.000) is less

than the computed percentage depletion ($ 25.000),
the allowable percentage depletion deduction is $
20.000
Example 11-13
Percentage Depletion
Gross income = $250,000
Mining expenses = $210,000
Percentage depletion = (10%)($250,000) = $25,000

Taxable Income = $250,000 - $210,000 = $40,000
Taxable Income Limitation = $40,000 (50%) = $20,000

Spreadsheet and Depreciation
Excel Functions Purpose

SLN(cost, salvage, Returns the straight-line depreciation of an asset for
life) one period.
DDB(cost, salvage, Returns the depreciation of an asset for a specified
life, period, [factor])
period using the double-declining balance method
or some other method specified.
SYD(cost, salvage, Returns the sum-of-years' digits depreciation of an
life, period) asset for a specified period.
VDB(cost, salvage, Returns the depreciation of an asset for any period
life, start_period, specified, including partial periods, using the
end_period, [factor], double-declining balance method or some other
[no_switch]) method specified. VDB stands for variable declining
balance.

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support the US edition of the text. In some

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• Basic Aspects of Depreciation

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• Understand the concepts of depreciation,

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Depreciation is the systematic

DEFINITION: A DECREASE IN VALUE

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Tangible property: can be seen, touched, and felt.

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• Almost all tangible property can be depreciated

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Pre-1981 classic methods:

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Cost of the asset, 𝐵𝐵 $900

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• If we convert to the straight line at year :

194,4 − 30 > $ 77,76 Convert to straight

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When a depreciable asset is disposed of, and the market

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4000 4000 4000

2000 2000 2000

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a) If market value = $7000, the recaptured depreciation = $7000

Market Value – Book Value = $5000 – 6667 = -1667 (Loss)

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• Useful when the recovery of depreciation on an asset is

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• Depletion allowance per 1000 board-feet

• The depletion allowance for the year

Cost of property (timber) = $35,000

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• Percentage depletion is an annual allowance of a percentage of

Since the taxable income limitation ($20.000) is less

Percentage depletion = (10%)($250,000) = $25,000

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Excel Functions Purpose

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