WEBVTT
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Welcome to the course depreciation alternate
investment and profitability analysis module
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one depreciation In this lecture today I will
tell about a depreciation method which is
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called modified accelerated cost recovery
system the modified accelerated cost recovery
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system which is called MACRS it stands for
the modified accelerated cost recovery system
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It is the current system allowed in the United
States to calculate the tax deductions on
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account of depreciation for depreciable assets
other than intangible assets Internal revenue
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services that is IRS form 4562 is used to
claim depreciation deduction It allows a larger
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deduction the early years and lower deduction
in late years when compared to the straight
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line method of deduction
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Modified accelerated cost recovery system
is the depreciation method used for most income
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tax purposes in USA and therefore also for
most economic evaluations The MACRS method
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is based on the classical double declining-balance
method but with no salvage value allowed that
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means for this system we take salvage value
is equal to zero and the switch to straight
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line at a point and use of the half-year convention
Since 1986 MACRS has been prevalent in USA
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Now what is the meaning of this half-year
convention The half-year convention indicates
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that in the first year only one half of the
double declining-balance method is allowed
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and the balance remaining after the end of
the recovery period is depreciated in the
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next year This leads to the strange result
that the MACRS depreciation always requires
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an additional year over the length of the
recovery period For MACRS the statutory percentage
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were based on a 200 percent declining-balance
for class lives of 3 5 7 and 10 years and
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a hundred fifty percent declining-balance
for class of lives of 15 and 20 years with
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a switch to straight-line depreciation at
the time appropriate to maximize the deduction
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The double-declining-balance method allows
a depreciation charge in each year of the
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recovery period that is twice the average
rate of recovery on the remaining underappreciated
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balance for the full recovery period for example
in the first year of a 5 year recovery period
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the fraction of the original depreciable investment
that can be taken as depreciation in DDBM
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is 2 into 1 by 5 because the salvage value
is zero
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In a straight line method the depreciation
will be 1 by useful life of the system So
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it is 1 by 5 and in a double declining-balance
method twice of the straight line depreciation
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is taken and that is why it becomes 2 into
1 by 5 or 40 percent The un-depreciated percent
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is now 60 percent of the original investment
Thus in the second year the allowable amount
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is 2 into 0.6 by 5 and so on Because this
method always takes a fraction of the remaining
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balance the asset is never fully depreciated
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The MACRS method overcomes this by employing
a shift to the straight line method in the
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year that the straight line depreciation provides
a higher depreciation rate than the double
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declining-balance method Accelerated cost
recovery system ACRS which was used before
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the use of modified accelerated cost recovery
system that is MACRS was used by companies
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which reported depreciation amount and provide
them with higher tax deduction
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What has happened ACRS used to give depreciation
cost which were higher in amount and thus
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the tax deductions were less in the early
years These tax deductions allow them to keep
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more of the revenue generated by these assets
This made it possible for companies to quickly
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repay any associated debts while increasing
their bottom life
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Perhaps the most dangerous trend to grow out
of the favorable tax treatment of capitalized
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assets was a large number of hostile takeovers
ACRS inadvertently unleashed a potent weapon
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for corporate raiders who specialize in leveraging
the assets of the target company to finance
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their attacks Responding to the criticism
the US congress revised the ACRS as part of
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the 1986 tax reform act
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The new depreciation method for tangible property
put in use after 1986 is called the modified
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accelerated cost recovery system that is MACRS
The main difference between ACRS and MACRS
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is that the later method uses longer recovery
periods and thus reduces the annual depreciation
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deductions granted for residential and the
non-residence real states
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Now the formula is this depreciation in the
first year is equal to cost 1 by service life
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into A into depreciation convention The half
yearly convention is basically a depreciation
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convention Now the depreciation in subsequent
years is cost minus depreciation in the previous
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years into 1 by service life into A where
A can be 100 percent 150 percent or 200 percent
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In a double declining method which is 200
percent method the A is 200 percent that means
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2 the value of A will be 2 and in 150 percent
DDBM it will be 1.5 Now this shows you the
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statutory percentage for the use in the modified
accelerated cost recovery system MACRS and
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the class lifes are 3 year 5 year 7 year and
10 year
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Now this table gives the percentage of deduction
of the original value each year and here we
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are using the half-yearly convention that
means in the first year whatever depreciation
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will be calculated using DDBM half of it will
be charged Now we will take up a table from
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this table the five year convention and then
will try to find out from where this percentages
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have come up and we will try to justify through
calculations these percentages
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Now let us take an example through this example
we will prove Develop annual percentage of
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depreciation rate charged in MACRS for a 5-years
recovery period assets such as a chemical
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plant Now we should note that the MACRS method
is based on the classical double-declining-balance
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method but with no salvage value allowed that
means salvage value taken is zero a switch
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to straight line at a point and use of the
half-year convention
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Now this is the 5 year life period Now here
we see that in the first year we are charging
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20 percent of the original value the second
year 32 percent of the original value and
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in the third year 19.20 percent of the original
value and fourth year 11.52 percent of the
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original value and fifth year 11.52 percent
of the original value and in the sixth year
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5.76 percent of the original value Now here
we see that though it is 5 years life span
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product it is taking 6 year to depreciate
it And when we use the half-yearly convention
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then in the first year we are charging lesser
amount of the depreciation what is being calculated
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by the double declining-balance method
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Now we will prove the automatically that from
what this 20 percent 32 percent19.20 percent
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11.52 percent and again 11.52 percent and
5.76 percent has arrived And we will also
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show you that how to switch from double declining-balance
method to a straight line method at a point
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when either the depreciation calculated by
the double declining method is equal to the
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straight line method or the straight line
method computes better depreciation charges
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or more depreciation charges than the double
declining-balance method
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Now let us take this the double declining-balance
method we will compute a depreciation which
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is equal to 2 into 1 by 5 is equal to 0.4
or 40 percent As salvage value is zero the
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straight line method will compute a depreciation
which is 1 by 5 5 is service life
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and for double declining-balance method this
becomes two times and thus 2 by 1 by 5 The
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percentage calculated is 40 percent in the
first year but as we are using the half-year
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convention it reduces to half
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Due to the half year convention
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this reduces to 40 percent Now from this 20
percent if we check the 5 year life period
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table then the first entry in the first year
is 20 percent and this is the 20 percent which
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we have calculated Thus we are justifying
that 20 percent in the first year Now if we
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use the straight line method the straight
line method permits 1 by 5 that is 0.2 or
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20 percent also This is same as the method
we are permitting due to the half year convention
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which is also 0.2 and the straight line method
also computes 0.2
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Now for the second year 5 years life span
this is year this is 5 year life span In the
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first year it is 20 percent in the second
year this is 32 percent in the third year
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this is 19.20 percent and in the fourth year
this is 11.52 11.52 percent and the fifth
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year again it is 11.52 percent and in the
sixth year this is 5.76 percent We have computed
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already this so this has been checked
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Now in the second year the un-depreciated
balance is 0.8; how 0.8 1 minus 0.2 This is
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20 percent I have already paid up So this
is 1 minus 0.2 is 0.8 Now the depreciation
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using DDBM is equal to 2 into 0.8 by 5 and
this comes out to be 0.32 or 32 percent So
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we see that in the second year the depreciation
is 32 percent we have calculated and if we
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see here in the second year it is charging
32 percent So this is checked
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Now if we see the straight line method So
this is 4.5 years remaining because that was
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half year’s convention we deduced half-year
format So it is 4.5 years and the remaining
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balance is depreciation using straight line
method is remaining balance is 0.8 and remaining
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years is 4.5 this comes out to be 0.177 or
17.7 percent So what we find that the depreciation
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which is being calculated using the straight
line method is less than the DDBM method and
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that is why we will pick up DDBM in this case
and this is why we can use 32 percent deduction
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in the second year
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Now let us go to the third year Now un-depreciated
amount amount is 0.48 and how this has come
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1 minus 0.2 minus 0.32 1 minus 0.2 due to
this 20 percent deduction and due 30 percent
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deduction it is 0.32 So this is 0.48 and if
we calculate the depreciation due to DDBM
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it will be 2 into 0.48 divided by 5 which
will come out to be 0.192 that is 19.2 percent
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So we have seen that in the third year we
are deducing 19.2 percent as depreciation
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Now if I calculate the depreciation using
straight line method
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So straight line method
it is 3.5 years remaining and depreciation
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using straight line method
is equal to 0.48 divided by 3.5 which comes
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out to be 0.137 or 13.7 percent So as 13.7
percent is less than 19.2 percent I will select
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19.2 percent In this way it will change to
straight line method only when the depreciation
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computed by straight line method will be more
than the depreciation computed by the DDBM
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method
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Now let us go to the fourth year if you go
to the fourth year the un-depreciated amount
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is equal to 0.288 And how this has arrived
This is 1.0 minus 2.0 minus 0.32 minus 0.192
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This will give you 0.288 and if we use a depreciation
using DDBM method this will be 2 into 0.288
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divided by 5 that comes out to be 0.1152 or
11.52 percent Now if we use depreciation calculate
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depreciation using the straight line method
Now 2.5 years is remaining
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So depreciation using straight line method
is equal to 0.288 divided by 2.5 this comes
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out to be 0.1152 or 11.52 percent So here
both are equal This is 11.52 percent 11.52
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percent both are equal So either of it can
be taken
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So let us take the DDBM So this is correct
Now in the fifth year we will calculate the
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un-depreciated amount
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un-depreciated amount is 0.1728 or it has
come 1 minus 0.2 minus 0.32 minus 0.192 minus
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0.1152 Now the depreciation charged using
DDBM is equal to 2 into 0.1728 divided by
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5 this comes out to be 0.06912 or 6.912 percent
Now this depreciation if we calculate using
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straight line method so for straight line
method 1.5 years is remaining
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and
depreciation using straight line method
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is 0.1728 divided by 1.5 this comes out to
be 11.5 this is 0.1152 or 11.52 percent
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Now what we see that depreciation computed
by the straight line method is more than the
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depreciation computed by the double declining-balance
method and hence we will pick up this value
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So this is explained
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In the sixth year obviously the remaining
balance has to be charged has depreciation
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Because of the half-yearly convention there
is a depreciation charge left for this year
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It is equal to
the
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un-depreciated amount un-depreciated amount
is 0.0576 which comes out like this 0.2 minus
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0.32 minus 0.192 minus 0.1152 minus 0.1152
So we have to charge the depreciation charge
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will be 5.76 percent because whatever left
out amount has to be charged in the sixth
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year and this is 5.76 percent
this explained
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So we see that in MACRS system how these percentages
were arrived at for a 5 year life span The
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same type of calculation can be done for three
years five years seven years ten years and
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for fifteen and twenty years we have to use
the 150 percent double declining-balance method
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instead of 200 percent double declining-balance
method For the five years life span we have
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used 200 percent double declining-balance
method
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Now take the example number two M/s wind-power
recently installed 30 wind turbines at a cost
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of Rupees 100 million They started operation
on 30th may 2010 Calculate the depreciation
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under MACRS method for the turbines assuming
the half-year convention is relevant Assume
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that the company’s year end in 31 December
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Now this is the solution of it we will compute
it on the blackboard Now if we check from
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the standard tables we find that
wind power installations are a 5 year property
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So the government specifies that all wind
power installations are 5 year property that
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means it has to be depreciated within that
space of time But when I use the MACRS method
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it will be depreciated in 6 years because
we will be using half-year convention Now
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we say the year depreciation amount in Rupees
calculation using formula and then calculation
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using table
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In the table there are percentages are given
for 5 year property we will use those figures
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Now in 2010 the depreciation is 20 million
Rupees and how this is being calculated 100
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million is their cost 1 by 5 becomes straight
line depreciation into 2 becomes the double
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declining depreciation and into 0.5 because
it is half-year convention So this gives you
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20 million and from the table it is 100 million
into 0.2 So that gives you 20 million
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Now in the 2011 this is 32 Now this is 100
minus 20 depreciable amount is this now into
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2 into 1.5 and this is 100 into 0.32 This
is 20 percent this is 32 percent Now in 2012
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this is 19.2 millions now this is 100 minus
20 minus 32 into 2 into 1 by 5 and now this
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is 100 into 0.192 19.2 percent Now in 2013
this is 11.52 how we arrive at 11.52 this
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is 100 minus 20 minus 32 minus 19.2 into 2
into 1 by 5 or 100 into 0.1152 11.52 percent
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Now 2014 this is again 11.52 So here we will
calculate using the straight line method as
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discussed earlier and this is and based on
the remaining balance which is 5.76 million
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which will be computed which is the basically
50 percent of due to the half-year convention
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or the remaining amount will be charged in
2015
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Now let us summarize
The monetary value of an asset decreases over
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time due to the we use wear and tear or obsolescence
This we know now and for this purpose depreciation
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is charged because the depreciation fund is
being created to replace the equipment Now
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in the present lecture I have taken the modified
accelerated cost recovery method which is
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a very simple method and is useful in computing
the depreciation and this is used in USA for
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computing the depreciation amount Thank you