Tax
Ad valorem taxescanbepropertytax
orevendutyonimporteditems.
Propertyad valorem taxesarethe
majorsourceofrevenueforstateand
municipalgovernments.
Municipalpropertyad valorem taxes
arealsoknownas"propertytaxes".
Depreciation
Depreciation is the loss in value of property such as
machine, building, vehicle, or other investment over a
periodoftime,causedbyoneormoreofthefollowing
Unrepaired wear: accumulates as a function of
hoursofuse,severityofuse
Deteriorations: The gradual decay, corrosion, or
erosionoftheproperty
Obsolescence: reduction of value and due to
competition from newer and/or more productive
models.(driveneitherbyTechnologyorStyle)
Reduction in demand
Measuring depreciation
SinceDepreciation isthelossin value over
aperiodoftimeitmaybetracedbysimple
graphing the market value as a function of
time.
Annual
Newcost
Depreciations
BookValue
Salvage Value
n
Depreciation accounting
Depreciation accounting is the systematic division
of the depreciable valueof capitalinvestmentinto
annualallocationsoveraperiodofyears.
Reasons
To provide owners and manager with an estimate
of the current value of their capital investment.
Depreciation accounting for this purpose should
approximateactualmarketvalues.
Toaccountfordepreciationinamannerthatyields
the maximum possible tax benefits. Depreciation
accounting for this purpose may not exceed strict legal
guidelinebutneednotapproximatemarketvalues.
Important parameters to Determine
Depreciation
Estimatethepurchasingpriceorcostwhennew.
Estimate the economical life (time between
purchase new and disposal at resale or salvage
value),orrecoveryperiodfortaxpurpose.
Estimate the resale or salvage value (zero for tax
purpose).
Depreciation Methods
Straight line method
Sum Of-Year Digit method
Decline balance method
Sinking fund method (this method is
not widely used)
Straight line method
Straight line (SL) method depreciation is the
simplest method to apply the most widely used
methodofdeprecation.
Theannualdepreciation,Dm,isconstantandthus
thebookvalue,BVm,decreasebyauniformamount
[Link]
Depreciationrate,Rm=1/N(1)
AnnualDepreciation,Dm=Rm*(P-F)
=(P-F)/N(2)
Example 1
Given the data below, find the annual depreciation and
graphshowingthedepreciationeachyear.
Draglinepurchaseprice,P=Birr80,000
Resalevalueafter7yrs,F=Birr24,000
Solution
Purchaseprice,P=Birr80,000
Resalevalueafter7yrs,F=Birr24,000
Valuetodepreciate N=7equal
installments,(P-F)=Birr56,000
Dm=(P-F)/N=56,000/7=Birr8,000
The Sum-Of-Year Digit Method
This is an accelerated depreciation (fast write-off)
method,
Thismethodcalculatesdepreciationforeachyearasthe
totaloriginaldepreciablevaluetimesacertainfraction.
N N 1
1) SOYD
2
2)Theannualdepreciationatendofyearmis
N m 1
Dm P F
SOYD
3)TheBookValueattheendofyearmis
m N m / 2 0.5
Bvm P P F
SOYD
Example 2
Usingthesame,Birr80,000dragglingasinexample1,
findandplottheallowabledepreciationusingtheSOYD
[Link]
Yea Depreciation allowed For this Book Value, Bvm at EOYm
r year, Dm (in Birr )
m
7/28 X Birr 56,000 14,000 80,000-14,000 66,000
6/28 X Birr 56,000 12,000 66,000-12,000 54,000
5/28 X Birr 56,000 10,000 54,000-10,000 44,000
4/28 X Birr 56,000 8,000 44,000-8,000 36,000
3/28 X Birr 56,000 6,000 36,000-6,000 30,000
2/28 X Birr 56,000 4,000 30,000-4,000 26,000
1/28 X Birr 56,000 2,000 26,000-2,000 24,000
56,000
Declined balance method
The declined balance methods are the accelerated
depreciation methods that provide for a larger share of
thecostofdepreciationtobewrittenofintheearlyyear
lessinthelateryears.
1. The depreciation rate, R is the depreciation multiple
dividedbytheestimatedlife,n.
FordoubledeclineBalancemethod,R=2/N
For1.75declinebalancedepreciation,R=1.75/N
For1.5declinebalancedepreciation,R=1.5/N
BVm1 R
Declined balance method
[Link],m,and
givendepreciationrate,Ris
Dm RP1 R BVm1 R
m 1
or
[Link]:
Bvm=P(1-R)mprovidedthatBvmF
[Link],atwhichbookvalue,Bvmwilldeclineto
anyfuturevalue,F,is:
ln F / P
m
ln 1 R
Declined balance method
Note that the depreciation amount Dm is determined
by the book value only, and is not influenced by the
salvagevalueF(expectingtheBvm-Dm-1F).
Therefore,thebookvalueduringlateryearsmayfollow
anyofthefollowing
IfFisZeroorverylow,thenBvmmayneverreachF
BVmayintersectFbeforeN(BVisnotpermittedtobe
lessthanF)
BVmayintersectFatN(veryrarecase)
Sinking Fund method
Thismethodfirstsetupsavingaccount
(sinkingfund)andcalculatestheamount
ofannualpaymentsrequiredtogointo
fundsothataccumulatedprincipalplus
interestwillequalstheaccumulated
depreciationontheassetbytheendof
theassetseconomiclife.
Sinking Fund method
End of Sinking fund Balance or Annual
year Accumulate Depreciation Depreciatio
n
1 B5,902.70*(F/A,10%,1) B5,902.7
0 5,902.70
2 B5,902.70*(F/A,10%,2) B12,903 7,000.30
3 B5,902.70*(F/A,10%,3) B19,588 6,685.00
4 B5,902.70*(F/A,10%,4) B27,395 7,807.00
5 B5,902.70*(F/A,10%,5) B36,037 8,642.00
6 B5,902.70*(F/A,10%,6) B45,543 9,506.00
7 B5,902.70*(F/A,10%,7) B56,00 10,457.00
Sinking Fund method
Theamountofdepreciationallowedinany
oneyearcanbedeterminedbyeitheroftwo
methods.
[Link]
oftheprioryearfromtheaccumulateddepreciationattheend
ofcurrentyear.(seethelastcolumnoftheabovetable.)
[Link]
asthefuturevalueofonelumpsumdepositofAmade(m-1)
[Link]
yearequalsB5,902.70(F/P,10%,6)=B10,457.
Thedepreciationallowedforeachindividualyear
maybetotaledtoequalthefullallowable
depreciationfortheseven-yearperiod,asfollows.