Chapter 08

Introductory Mathematics & Statistics
Chapter 8 Depreciation
Copyright 2010 McGraw-Hill Australia Pty Ltd PowerPoint slides to accompany Croucher, Introductory Mathematics and Statistics, 5e
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Learning Objectives
Use the latest depreciation rules of the Australian Taxation Office Calculate depreciation using the prime cost (straight line) method Calculate depreciation using the diminishing value (reducing balance) method Calculate depreciation rates using the units-of-production method Prepare a depreciation schedule Calculate the current written-down value (book value) of an asset
Keep depreciation records
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8.1 Introduction
Depreciable assets
The value of an asset gradually reduces over time as it approaches the end of its useful life. Assets that lose value in this way are said to depreciate The amount of this lost value is called depreciation and represents a depreciation expense The assets themselves are known as depreciable assets, and each one has limited effective life
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8.1 Introduction (cont)

Possible causes of depreciation include
physical deterioration obsolescence inadequacy lack of utility exhaustion the passage of time
The cost of an item for depreciation purposes includes:

the original purchase price or construction cost transport costs installation costs customs duty relocation costs
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The depreciation provisions apply to plant, which means articles or assets that are used to produce assessable income, or are installed ready for use to produce income and are held in reserve. Examples include:
computers electrical tools furniture and fittings furnishings manufacturing machinery motor vehicles
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Simplified depreciation rules
If you choose to use the simplified depreciation rules, you must use them to work out deductions for all your depreciating assets that the rules apply to You can pool into a general small business pool and deduct at the rate of 30% most other depreciating assets with effective lives of less than 25 years If the depreciating assets have effective lives of 25 years or more they can be pooled into a long-life small business pool and deducted at the rate of 5%
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8.2 The simplified tax system

The simplified (depreciation) rules under the simplified tax system (STS) provide small businesses with significant concessions These rules involve simpler calculations and remove the need to calculate depreciation separately for each asset
Under the simplified depreciation rules, you can claim an immediate deduction for most depreciating assets costing less than $1000 and pool most other depreciating assets
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8.2 The simplified tax system (cont)

Small business pools
You may combine assets into small business pools as follows: the general small business poolfor assets with effective lives of less than 25 years the long-life small business poolfor assets with effective lives of 25 years or more If you held any assets at the start of the income year that you chose to use these rules, you must generally allocate them to a pool at the beginning of that year The opening pool balance is the taxable-purpose proportion of the adjustable values of all depreciating assets in your pool
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Using the simplified depreciation rules for the first time
When you first use the simplified depreciation rules, you must work out each pools opening balance In later years, you must review, and in some cases adjust, the opening pool balance for the changes to taxable purpose proportion before working out your pool deduction
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Continuing to use the simplified depreciation rules
In later years, you may need to adjust the opening pool balance before calculating your pool deduction if you:
change the extent to which you use a pooled asset for a taxable purpose, or have assets that you started to use, or hold ready to use, since last choosing to use these rules
The adjustment will ensure that your pool deduction is based on the correct estimate of the adjustable value of all your assets and their taxable-purpose proportions for the current and future income years
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Adjustable value
You must work out the adjustable value of each depreciating asset you start to use, or have installed ready to use, for a taxable purpose The adjustable value of an asset is its cost less its decline in value since you first used it The assets cost does not include any amount that you can claim as a GST credit
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Low-cost assets
A low-cost asset is one whose cost at the end of the year you first used it for a taxable purpose is less than $1000 (Note: This definition excludes horticultural plants) You use an asset for a taxable purpose if you use it to produce assessable income You can claim an immediate deduction for low-cost assets in the income year that you first use those assets, for a taxable purpose
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8.3 Methods of depreciation

You can work out the decline in value of a depreciating asset using either the prime-cost method (also known as the straight-line method) or the diminishing-value method (also known as the reducing-balance method) Once a particular method of depreciation for an item is adopted, you may not change to the other method for that item For most depreciating assets, you can choose whether to self-assess the effective life or adopt the taxation Commissioners determination
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8.3 Methods of depreciation (cont)

Non-business use
A deduction for the decline in value of a depreciating asset is not allowable if the depreciating asset is used solely for private purposes
Assets held at the start of the year

How you apply the simplified depreciation rules to depreciate assets that you held at the start of the year depends on whether this is the first year you are using the rules or whether you have used them in a previous year
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Depreciating assets held before 1 July 2001
To work out the decline in value of depreciating assets you held before 1 July 2001, you generally use the same cost, effective life and method that you were using under the former law The undeducted cost of the asset at 30 June 2001 becomes its opening adjustable value at 1 July 2001
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Depreciation rates
Rates of depreciation are fixed by reference to the effective life of each asset The effective life of a particular item is the period for which the item can reasonably be expected to be used in producing assessable income The salvage value (or scrap value) of an asset is its estimated value, if any, at the end of its effective life Once an asset has been depreciated, it is then said to have a certain book value Book value = original cost of asset depreciation to date
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8.4 Prime cost method (straight line method)

The prime cost method assumes that the value of a depreciating asset decreases uniformly over its effective life
days held 100 % Annual depreciation asset's cost 365 asset's effective life
Note that 365 is replaced by 366 in a leap year The annual rate of depreciation (as a percentage) is given by:
Annual rate of depreciation
annual depreciation 100% original value of asset
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8.4 Prime cost method (straight line method) (cont)

Example
Wendy purchased a photocopier for $1500 on 8 August 2009. Determine the depreciation for this item for the 200910 income year using the prime cost method.
Solution
From Table 8.2, the effective life of a photocopier is 5 years. The number of days from 8 August 2009 to 30 June 2010 (inclusive) is 327
327 100% Depreciation during 2009 10 $1500 365 5 $269
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8.5 Diminishing value method (reducing balance method)

The diminishing-value method assumes that the depreciation of an asset is highest in the earliest years of its life and calculates it as a fixed percentage of the preceding book value This is done because many assets (e.g. machines) are more productive when new and become less efficient as they get older
Depreciation for yea r k book value at e nd of k-1 depreciation rate
Note that the book value at the end of year 0 is defined to be the original cost The depreciation rate represents the fraction of the book value that is depreciated each year
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8.5 Diminishing value method (reducing balance method) (cont)

For depreciating assets held initially prior to 10 May 2006 the formula for the decline in value is:
Amount of depreciation opening adjusted value days held 1.5 asset's effectivel ife 365
For depreciating assets held initially after 10 May 2006, the formula for the decline in value is:
opening adjusted value days held 20 asset's effectivel ife 365
Amount of depreciation
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8.6 Units of production method

The units of production method deals with items that deteriorate more with use rather than age In this case, the effective life is determined by total output rather than age Examples of items for which this method may well be appropriate include
tyres on a vehicle machine parts cutting blades photocopiers printers or any items in continuous use
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8.6 Units of production method (cont)

The units-of-production method of depreciation is similar to the prime-cost method, but the rate is expressed as a usage rate rather than a time rate
original value of asset Rate of depreciation effective life in output terms
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8.7 Record keeping

If a deduction for depreciation is claimed in a tax return, the following information must be kept:
the undeducted cost and written-down (book) value of each asset at the start of the income year for each asset disposed of during the year, the cost and sale price, dates of acquisition and disposal, and the undeducted cost and written-down value of the asset the adjustments made to cost, undeducted cost and writtendown value details of balancing charge relief, including the alternative treatment of assessable adjustments the rate and amount of depreciation claimed for each asset the undeducted cost and written-down value of each asset at the end of the income year
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Summary
We used the latest depreciation rules of the Australian Taxation Office We calculated depreciation using the prime cost (straight line) method We also calculated depreciation using the diminishing value (reducing balance) method And we calculated depreciation rates using the units-ofproduction method We calculated the current written-down value (book value) of an asset Finally we looked at keeping depreciation records
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Introductory Mathematics & Statistics

Keep depreciation records

8.1 Introduction (cont)

The cost of an item for depreciation purposes includes:

8.1 Introduction (cont)

8.1 Introduction (cont)

8.2 The simplified tax system

8.2 The simplified tax system (cont)

8.2 The simplified tax system (cont)

8.2 The simplified tax system (cont)

8.2 The simplified tax system (cont)

8.2 The simplified tax system (cont)

8.3 Methods of depreciation

8.3 Methods of depreciation (cont)

Assets held at the start of the year

8.3 Methods of depreciation (cont)

8.3 Methods of depreciation (cont)

8.4 Prime cost method (straight line method)

Annual rate of depreciation

annual depreciation 100% original value of asset

8.4 Prime cost method (straight line method) (cont)

327 100% Depreciation during 2009 10 $1500 365 5 $269

8.5 Diminishing value method (reducing balance method)

Depreciation for yea r k book value at e nd of k-1 depreciation rate

8.5 Diminishing value method (reducing balance method) (cont)

8.6 Units of production method

8.6 Units of production method (cont)

original value of asset Rate of depreciation effective life in output terms

8.7 Record keeping

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