Just as you pay rent for your room or apartment, you also pay "rent" for money you borrow. This "rent" is called interest.
Borrow $100 now (called principal) for 1 year
Lump sum repayment at end of year is $110
We see that $100 now is equivalent to $110 a year from now at the stated interest terms.
A contractor’s working capital could be invested if it were not needed as working capital.
Therefore, the interest that could have been earned was not, so it is really a cost of doing business; just as is the interest paid on borrowed capital.
A contractor’s idle equipment isn’t earning revenue but its cost, principal and interest, must be paid.
Ability to keep assets employed helps drive decision to buy, lease or rent.
Tax impact on profit must be considered
~ Depreciation deductions for equipment
Uniform series End-of-period payments:
Tables of compounded amount factor values are arranged by i and n values. Their use speeds calculations.
Depreciation is the loss of value of equipment over a period of time (I.e., a declining book value).
Tax depreciation is an artificial dollar value devised primarily to facilitate deduction accounting for income tax purposes.
Actual depreciation (or appreciation) is the actual change in market value of equipment.
Depreciation accounting is the systematic division of the depreciable value of equipment into annual depreciation allocations over a set period of years.
Depreciation accounting requires knowledge of:
~economic life or depreciable life (n)
~ resale/salvage value (unless depreciated to zero value)
Commonly used depreciation methods:
~sum-of-the-year digits (SOYD)
Federal income tax depreciation methods changed due to the "Economic Recovery Tax Act" of 1981 introducing an "Accelerated Cost Recovery System" (ACRS) depreciation method.
Under ACRS all property has a 3-, 5-, 10- or 15-year recovery period depending on its type. Each period has a fixed schedule of depreciation percentages.
(Ex: 3-yr period is 25%, 38% & 37% for 1981 - 1984)
Under ACRS, actual life is neglected and salvage value is figured at zero.
~most commonly figured as cost per unit of time but can be based on cost per unit of work
~an accelerated method of depreciation using an equal fraction times each year’s book value
~ depreciation value = current book value × DB rate
new current book value = previous current book value - depreciation value
~ do not let book value go below salvage value or zero
~an accelerated method of depreciation using a changing fraction times depreciable value
~see Collier’s Cost Analysis text for more explanation
Dm = annual depreciation in year m
P = purchase price of depreciable asset
F = salvage value (resale value) of asset
BVm = book value at end of any year, m, after depreciation for that year
m = age of asset at time of calculation
SOY = sum of the ordinal digits for each of the years 1 through n,
R = depreciation rate for declining balance depreciation
for double declining balance, R = 2/n ;
for 1½ declining balance, R = 1.5/n ;
for 1¼ declining balance, R = 1.25/n
A machine is purchased for $9,000. Its estimated economic life is 10 years, after which it will be sold for $1,000. Find the depreciation and book value in the first three years using SL, DDB and SOYD at 6%.
* Note: Find the value of the denominator given the value of the numerator
(for example, P/F means find P, given F; P/A means find P given A,
This document was produced using an evaluation version of HTML Transit 2
Declining balance (DB)
