Depreciation Methods

listed for informational purposes only

Depreciation Methods in Sage FAS 50 Asset Accounting and Sage FAS 100 and 500 Asset Accounting.

[bonus depreciation for 2010 and 2011 fixed assets]

• MACRS
  ACRS
  Straight-Line
  Declinging Balance
  Sum of the Years Digits
  Remaining Value Over Remaining Life

>> 14 Reasons Not to Use A Spreadsheet For Depreciation

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MACRS Methods

The Tax Reform Act of 1986 created a number of changes in the way depreciation is calculated for all assets acquired after December 31, 1986. This tax act made significant changes to the earlier Accelerated Cost Recovery System (ACRS), and created the modified ACRS (MACRS).

Recovery periods were generally extended. The typical recovery period for most personal property increased from 5 to 7 years, using 27.5 years for residential real property and 31.5 years for nonresidential real property. (The Revenue Reconciliation Act of 1993 extended the life of nonresidential real property placed in service after May 12, 1993, to 39 years.) A 200% declining-balance MACRS formula replaced the 150% declining-balance ACRS tables. The recovery rate for real property also fell from 175% declining-balance to a straight-line computation in MACRS.

The MACRS methods created by the Tax Reform Act of 1986 are mandatory for most tangible property placed in service after December 31, 1986. Taxpayers could also choose to use MACRS for certain transitional property placed in service after July 31, 1986, and before January 1, 1987. Post-1986 depreciation on property placed in service before 1987 will continue to be computed under the method used when the property was placed in service.

There are three standard MACRS depreciation methods: MACRS formula, MACRS table, and Alternative Depreciation System (ADS) straight-line MACRS. A fourth depreciation method, MACRS method MI, permits entry of the shorter recovery periods allowed for qualifying Indian Reservation property. Method MI is available for qualified assets placed in service after 12/31/93 and before 2010.

ACRS Methods

The Accelerated Cost Recovery System (ACRS) is an IRS-prescribed method for recovering the cost of personal and real property placed in service from 1981 through 1986. ACRS is a modification of the Asset Depreciation Range (ADR) method used in the 1970s. It was created by the Economic Recovery Tax Act of 1981, which required the use of ACRS or alternate ACRS for assets placed in service from 1981 through July 1986. ACRS may have been elected for qualifying assets through December 31, 1986. For tax purposes, assets acquired after 1986 (other than transitional property) must use one of the MACRS methods.

The application supports three ACRS methods: ACRS table; straight-line, alternate ACRS formula; and straight-line, alternate ACRS table. The two straight-line, alternate ACRS methods are essentially the same, except that rounding in the IRS tables produces small differences from the formula calculation in the recovery amount per period.

Straight-Line Methods

The straight-line method is the simplest and most commonly used method for calculating depreciation. It can be used for any depreciable property, but it is not generally allowed for ACRS or MACRS property, which for tax purposes must use ADS straight-line MACRS (method AD) or straight-line, alternate ACRS (methods SA and ST) for straight-line treatment. Under the straight-line depreciation method, the basis of the asset is written off evenly over the useful life of the asset. The same amount of depreciation is taken each year.

The straight-line method is approved under Generally Accepted Accounting Principles (GAAP) and is frequently used for internal books. In general, the amount of depreciation equals an asset's depreciable basis divided by its estimated life.

The application supports four standard straight-line methods, each using a different averaging convention: Midmonth, Full month, Half-year, and Modified half-year.

Declining-Balance Methods

Declining-balance depreciation is a method that depreciates an asset at a higher rate in the earlier years of the asset's life than straight-line depreciation. It applies only to tangible assets with a useful life equal to or greater than 3 years. According to tax law, for new assets placed in service from 1954 through 1980, declining-balance rates were allowed to a maximum of twice the straight-line rate (200%). When you enter a declining-balance method, you select the rate you want to apply.

Using declining-balance depreciation for each year of an asset's life never completely depreciates the asset. Therefore, the IRS lets you switch from declining-balance depreciation to straight-line depreciation once during the life of an asset. This switch is one of few changes in depreciation method that you can make without special IRS approval.

The application provides six standard declining-balance methods. When paired with the four possible depreciation rates (125%, 150%, 175%, and 200%), you have 24 choices.

Each method is different based on the percentage used, the averaging convention used, and whether it will switch from declining-balance to straight-line at the optimal point. The optimal point for switching to straight-line depreciation is when the deductions allowed by the straight-line method equal or exceed the deductions allowed by the declining-balance method. When the change to straight-line is made, the unrecovered basis of the asset is spread over the remaining estimated life, ensuring that the entire amount is depreciated. When straight-line depreciation is applied in this way, it is often called remaining value over remaining life depreciation. The methods are as follows:

Sum-of-the-years-digits Method

Sum-of-the-years'-digits depreciation is another way to accelerate the depreciation of an asset. It can result in deductions that are larger than those given by double declining-balance depreciation in the early years. Although the deductions get smaller each year, all of the asset's depreciable basis is written off over the property's useful life. It applies only to tangible assets with a useful life equal to or greater than 3 years.

For the Tax book, sum-of-the-years'-digits depreciation is normally used only for assets placed in service before 1981.

The application provides three standard sum-of-the-years'-digits depreciation methods, each using a different averaging convention: Midmonth, Half-year, Modified half-year.

Remaining Value Over Remaining Life Method

Remaining value over remaining life is similar to straight-line depreciation. What makes it unique is that while the straight-line calculation is static, the remaining value over remaining life calculation is dynamic. If there is a change in a critical value (for example, the asset's estimated life), the straight-line method cannot adjust its future calculations so that the asset is fully depreciated at the end of its life. The remaining value over remaining life method, on the other hand, takes the asset's remaining depreciable basis and depreciates that amount evenly over the asset's remaining estimated life.

Converting to remaining value over remaining life is generally the best way to take an adjustment evenly over the rest of an asset's life. It is the suggested approach to handling a change in an accounting estimate under the Accounting Principles Board (APB) Opinion Number 20.

If you choose the remaining value over remaining life method for an asset in the year you placed the asset in service, and if you placed the asset in service on or before the 15th of the month, the depreciation calculated is identical to that calculated using the straight-line method.

 

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