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. It is an accounting concept an annual deduction against before tax income such that the effect of time can be reflected in a firms financial statement. A non-cash cost that affects income taxes. Can involve deterioration or obsolescence Depreciation accounting is to account for the cost of fixed assets in a pattern that matches their decline in value EMM3604 Cost Accounting and Engineering Economy over time.
Assoc.Prof Dr.Rosnah Mohd.Yusuff
Asset Depreciation
Fixed Assets resources that are acquired to provide future cash flows. Economic depreciation Physical dep
The gradual decrease in utility in an asset with use and time. Functional dep
Depreciation
Accounting depreciation The systematic allocation of an assets value in portions over its depreciable life
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Physical dep
a reduction in an assets capacity to perform its intended service due to physical impairment. due to interaction with environment corrosion, rotting and due to wear and tear of use.
Functional dep
as a result of changes in the organization or in technology obsolescence, declining need of the asset, or inability to meet increased quantity and/or quality demands.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Economic dep Economic dep =purchase price market value Accounting dep use to assess financial position of organization. Asset dep, cost of fixed assets are capitalized their costs are distributed by subtracting them as expenses from gross income. A fraction of the cost of the asset is chargeable as an expense in each accounting period in which the asset provide service to the firm.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Cont
Depreciable Property
a. It must be used in business or held to produce income b. It must have a definite service life, and that life must be longer than a year. c. It must be something that wears out, decays, get used up, obsolete, or loses value from natural causes. d. It is not inventory, stock in trade, or investment property.
Definitions
Adjusted (Cost) basis original cost basis of the asset, adjusted by allowable increases or decreases. Ex. cost of any improvement to a capital asset with a useful life greater than one year, the original cost basis. Casualty or theft loss. Basis, or cost basis initial cost of acquiring an asset (purchase price + any sales taxes), including transportation expenses and other expenses making the asset serviceable.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Cont
Book Value (BV) the worth of a depreciable property shown on the accounting records of a company. Original cost basis include any adjustments, less all allowable depreciation or depletion deductions. (Book Value) = adjusted cost basis - (dep deduction) Market Value (MV) the amount that will be paid by a willing buyer to a willing seller. The MV J=1 approximates the present value of what will be received through ownership of the property, including the time value of money.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Definitioncont
Recovery period
The number of years over which the basis of a property is recovered through the accounting process.
Recovery rate
A percentage (in decimal form) for each year of the MACRS recovery period that is utilized to compute an annual depreciation deduction.
Definitioncont
Recovery period
The number of years over which the basis of a property is recovered through the accounting process.
Recovery rate
A percentage (in decimal form) for each year of the MACRS recovery period that is utilized to compute an annual depreciation deduction.
Useful life
Example:
A company purchased an automatic hole-punching machine priced at RM62, 500. The vendors invoice included a sales tax of RM3263. The company also paid the inbound transportation charges of RM725 as well as labour cost of RM2150 to install the machine in the factory. The site was also prepared before installation at a cost of RM3500. Determine the cost basis for the new machine for depreciation purpose. Cost of new machine RM62,500 Freight 725 Installation Labour 2,150 Site Preparation 3,500 Cost of machine (cost basis) RM68,875
Depreciation Methods
1. 2. Book dep for financial reports, balance sheet, income statement. Tax dep for calculating taxes. depreciating assets more quickly allows firms to defer paying income taxes. Permit a higher dep in earlier years than book dep, tax benefit is enjoyed earlier. Pay lower taxes in earlier years, better cash position because of time value of the funds.
1. straight line method 2. accelerated method DB, SOYD. 3. unit of prod method
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
SLcont
dk d* BV = = = (B - SVn) / N d for 1 k N B - d
N =depreciable life of the assets in years B =cost basis d =annual dep deduction in year (1 N) BV=book value at the end of year SV=estimated salvage value at end year N d* =cumulative dep through year
SLexample
A new electric saw for cutting small pieces of lumber in a furniture manuf. Plant has a cost basis of RM4000 and a 10-year depreciable life. The estimated SV of the saw is zero at the end of 10 yrs. Determine the annual dep using SL and the BV at the end of each year.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
SLexample (cont)
d = at year 5, d5 = d*5 = BV = = (4000 0) / 10 RM 400 5 (4000 0) =RM 2000 10 4000 5(4000-0) 10 RM 2000
SLexample (cont)
EOY, 0 1 2 3 4 5 6 7 8 9 10
RM400 400 400 400 400 400 400 400 400 400
dk
BVR RM 4000 3600 3200 2800 2400 2000 1600 1200 800 400 0
DBcont
D1 = D2 D3 Dn Bn Ii = (I D1) = I (1-) = (I D1- D2) = I (1 ) = I (1-) n-1 = I (1-) n
DBExample
DBExample (cont)
Use same a. = d6 = d*6 = BV6= example as SL:2/N = 0.2 4000 (1-0.2)5 (0.2) = 4000 [ 1-(1-0.2)6 ] = 4000 (1-0.2)6 =
b. = 1.5/N = 0.15 d6 = 4000 ( 1- 0.15)5 (0.15) = RM266.22 d*6 = 4000 [ 1 (1 - 0.15)6] = RM2491.40 BV6 = 4000 (1 0.15)6 = RM1508.60 Using = 0.2
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
DBExample (cont)
EOY, 0 1 2 3 4 5 6 7 8 9 10 d 800 640 512 409.60 327.68 262.14 209.72 167.77 134.22 107.37 BV 4000 3200 2560 2048 1638.40 1310.72 1048.58 838.86 671.09 536.87 429.50
SOYDexample
Using same ex: d4 = 400 [ 7 / 25 ], N = 10 = 509.09
SOYD = 10 (11) = 55 2
SOYDexample (cont)
EOY, 0 1 2 3 4 5 10 d 727.27 645.55 581.82 509.09 436.36 72.73 BV 4000 d1 = 4000 (10 / 55) 3272.73 d2 = 4000 (9 / 55) 2618.18 d3 = 4000 (8 / 55) 2036.36 1527.27 109.91 0
DB switchover to SL DB BV never reaches zero can switch to SL Switchover occur when SLDep > DBdep
DB switchover to SLex d6 = RM262.14, BV6 = RM1048.58 BV10 = RM429.50 With switchover, BV10 = 0, since in year 6 Dbdep = SLdep= RM262.14 switch to SL thru year 7-10, SLdep>DBdep
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Example (cont)
BOYear, DB SL BV 6 262.14 = 262.14 1310.72 7 209.72< 262.14 1048.58 8 167.77< 262.14 786.44 9 134.22< 262.14 524.30 10 107.37< 262.14 262.16 Total depreciation : DDB = RM3,570.50
SL =
RM4000.
Example
A piece of equipment has a basis of RM50,000 and SV is RM10,000, when replaced after 30,000 hrs. of use. Find the dep rate per hour of use, and its BV after 10,000 hrs of operation.
RM1.33
(10,000)
Practice in US
1981-ACRS 1986 MACRS asset dep law dictate depreciation rates for all personal and real property take advantage of accelerated methods of capital recovery
MACRS (cont)
MACRS Dt = dtB dt = dep rate provided by the Govt. Book Value, BVt = BVt-1 - Dt BVt = first cost sum of j=t acc. dep j=1 = B Dj
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
MACRS (cont)
First cost B is always completely depreciated as MACRS assumes that the estimated SV=0. Recovery periods are standardized to the values of 3,5,7,10,15 and 20 years for personal property. For real property commonly 39 years, possible to justify 27.5 year recovery period. For Annual Dep: First Cost (unadjusted) X MACRS rate (from table). the dep rate incorporate the DDB method (d = 2/n) and switch to SL dep during recovery period for property starts with DDB (dt = 2/n) SL rate (dt = 1/n) when SL method offers a faster write-off.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
MACRS (cont)
Real property -SL method for n = 39. Annual percentage dep rate =1/39 = 0.02564. the MACRS forces partial recovery in years 1 to 40.
Year 1 1.391% Year 2 39 2.564% Year 40 100 d1 100 dt 100 d40 = = = 1.177%.
MARCS dep rates are presented for 1 year longer than stated recovery period n. is built in half year convention imposed by the MACRS system.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Why??? a. Reduced Performance deterioration of parts, expected level of reliability/productivity is not achieved, increased cost of operation, higher scrap and rework costs, lost sales, and larger maintenance expenses. b. Altered requirements - New requirements accuracy, speed etc. c. Obsolescence - competition, rapidly changing technology of automation, computers, communication.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Replacement Analysis
Sunk cost should not be included in the economic analysis. It represents capital loss.
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff
Interest
Interest rate : Percent interest rate = interest accrued per time unit x 100% original amount unit of time used interest period
EMM3604 Cost Accounting and Engineering Economy Assoc.Prof Dr.Rosnah Mohd.Yusuff