Depreciation methods study guide

Straight-Line Depreciation →

A method where the asset's cost is evenly spread over its useful life. Formula: $\displaystyle \text{Depreciation Expense} = \\frac{\text{Cost} - \text{Salvage Value}}{\text{Useful Life}}$.

True or False: Depreciation affects cash flow.

False. Depreciation is a non-cash expense that reduces taxable income but does not directly impact cash flow.

What is Accelerated Depreciation?

A method that expenses a higher amount in the early years of an asset's life, allowing for faster recovery of costs.

Question: How does Double Declining Balance method work?

It applies double the straight-line rate to the declining book value of the asset each year.

Cause → Effect: Choosing a depreciation method.

Choosing a method affects financial statements, tax liabilities, and cash flow management.

Fill in the blank: The ________ method allocates depreciation based on usage.

Units of Production. It ties depreciation to the actual output produced, not time.

Comparison: Straight-Line vs. Declining Balance.

Straight-Line: Equal expense yearly. Declining Balance: Higher expense initially, decreasing over time.

Question: What is Salvage Value?

The estimated value an asset will have at the end of its useful life, before disposal.

True or False: All assets depreciate.

False. Land does not depreciate, as it generally appreciates in value over time.

Example: If an asset costs $\displaystyle 10,000, salvage value$1,000, useful life 5 years, calculate SL depreciation.

$\displaystyle \text{Depreciation Expense} = \\frac{10,000 - 1,000}{5} = 1,800$ per year.

What is Modified Accelerated Cost Recovery System (MACRS)?

A method established by the IRS that allows for accelerated depreciation of assets over specified recovery periods.

Question: Why consider depreciation in financial planning?

Depreciation affects financial statements, tax liabilities, and future investment decisions, influencing overall financial health.

Double Declining Balance Method →

An accelerated depreciation method that doubles the straight-line rate. Formula: Depreciation Expense = 2 × (Straight-Line Rate × Book Value)

True or False: Straight-line method gives higher initial expense.

False. Straight-line spreads costs evenly, resulting in lower initial expenses compared to accelerated methods.

Calculate: Year 1 Depreciation, Cost $10,000, Life 5 years.

Straight-line method: Depreciation = $\displaystyle 10,000 / 5 =$2,000 for Year 1.

Units of Production Method →

Depreciation based on actual usage. Formula: Depreciation = (Cost - Salvage Value) / Useful Life in Units × Units Produced.

Comparison: Straight-line vs. Declining Balance

Straight-line: Equal expense each year. Declining Balance: Larger expense initially, reduces over time.

Fill in the blank: Salvage value is the ________ value of an asset.

Residual or expected resale value at the end of its useful life.

Question: What is Modified Accelerated Cost Recovery System (MACRS)?

A tax depreciation system in the U.S. that allows for accelerated depreciation over specified asset classes.

Cause → Effect: Choosing an accelerated method leads to ______.

Higher depreciation expenses in early years, reducing taxable income initially.

True or False: Depreciation affects cash flow directly.

False. It is a non-cash expense; impacts net income but not cash flow directly.

Question: What is the main purpose of depreciation?

To allocate the cost of tangible assets over their useful lives and match expenses with revenues.

Calculate: Moving Average Depreciation for 3 years with costs $\displaystyle 5,000,$6,000, $7,000.

Average cost = ($\displaystyle 5,000 +$6,000 + $\displaystyle 7,000) / 3 =$6,000.

Comparison: Depreciation vs. Amortization

Depreciation: Tangible assets. Amortization: Intangible assets.