Depreciation and Income Taxes
Depreciation and Income Taxes
• Taxes have been collected since the dawn of civilization.
• Income taxes usually represent a significant cash outflow
that cannot be ignored in decision making.
• Depreciation
p affects income taxes and income taxes
affect economic decision making.
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Depreciation When is a Property Depreciable?
• Decrease in value of physical properties with
passage of time and use
• In general, property is depreciable if it meets the
• Accounting concept establishing annual deduction following basic requirements:
against before-tax income
– to reflect effect of time and use on asset’s value in firm’s – It must be used in business or held to produce income.
financial statements – It must have a determinable useful life which is longer than
– to match yearly fraction of value used by asset in production one yyear.
of income over asset’s economic life – It must be something that wears out, decays, gets used up,
becomes obsolete, or loses value from natural causes.
• The actual amount of depreciation can never be – It is not inventory, stock in trade, or investment property.
established until the asset is retired from service.
• Because depreciation is a noncash cost that affects
income taxes, we must consider it properly when
making after-tax engineering economy studies.
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, Depreciable Property When Depreciation Starts and
Stops?
• TANGIBLE - can be seen or touched
• Depreciation starts when property is placed in service
personal property includes assets such as
- for use in business or for production of income
machinery, vehicles, equipment, furniture, etc... • Property is considered in service when ready and
real property - anything erected on, growing on, or available for specific use, even if not actually used yet
attached to land • Depreciation stops when cost of placing it in service is
recovered or it is retired from service
(Since land does not have a determinable life
itself, it is not depreciable)
• INTANGIBLE - personal property, such as copyright,
patent or franchise
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Depreciation Concepts Depreciation Concepts
• Book Value (BV) -- Worth of depreciable property as
• Basis, or cost basis -- also called unadjusted cost -- shown on accounting records
initial cost of acquiring an asset, plus sales tax,
transportation, and normal costs of making asset Original cost basis of property, including
serviceable adjustments, less allowable depletion or
• Adjusted cost basis -- allowable adjustment (increase depreciation
p deductions
or decrease) to original cost basis, used to calculate Represents amount of capital remaining invested
depreciation and depletion deductions in property and must be recovered in future through
accounting
(Book Value)k = adjusted cost basis - Σkj=1 (depreciation deduction)j
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Depreciation and Income Taxes
• Taxes have been collected since the dawn of civilization.
• Income taxes usually represent a significant cash outflow
that cannot be ignored in decision making.
• Depreciation
p affects income taxes and income taxes
affect economic decision making.
Slide 1 of 46 Industrial &Production Engineering Slide 2 of 46 Industrial &Production Engineering
Depreciation When is a Property Depreciable?
• Decrease in value of physical properties with
passage of time and use
• In general, property is depreciable if it meets the
• Accounting concept establishing annual deduction following basic requirements:
against before-tax income
– to reflect effect of time and use on asset’s value in firm’s – It must be used in business or held to produce income.
financial statements – It must have a determinable useful life which is longer than
– to match yearly fraction of value used by asset in production one yyear.
of income over asset’s economic life – It must be something that wears out, decays, gets used up,
becomes obsolete, or loses value from natural causes.
• The actual amount of depreciation can never be – It is not inventory, stock in trade, or investment property.
established until the asset is retired from service.
• Because depreciation is a noncash cost that affects
income taxes, we must consider it properly when
making after-tax engineering economy studies.
Slide 3 of 46 Industrial &Production Engineering Slide 4 of 46 Industrial &Production Engineering
1
, Depreciable Property When Depreciation Starts and
Stops?
• TANGIBLE - can be seen or touched
• Depreciation starts when property is placed in service
personal property includes assets such as
- for use in business or for production of income
machinery, vehicles, equipment, furniture, etc... • Property is considered in service when ready and
real property - anything erected on, growing on, or available for specific use, even if not actually used yet
attached to land • Depreciation stops when cost of placing it in service is
recovered or it is retired from service
(Since land does not have a determinable life
itself, it is not depreciable)
• INTANGIBLE - personal property, such as copyright,
patent or franchise
Slide 5 of 46 Industrial &Production Engineering Slide 6 of 46 Industrial &Production Engineering
Depreciation Concepts Depreciation Concepts
• Book Value (BV) -- Worth of depreciable property as
• Basis, or cost basis -- also called unadjusted cost -- shown on accounting records
initial cost of acquiring an asset, plus sales tax,
transportation, and normal costs of making asset Original cost basis of property, including
serviceable adjustments, less allowable depletion or
• Adjusted cost basis -- allowable adjustment (increase depreciation
p deductions
or decrease) to original cost basis, used to calculate Represents amount of capital remaining invested
depreciation and depletion deductions in property and must be recovered in future through
accounting
(Book Value)k = adjusted cost basis - Σkj=1 (depreciation deduction)j
Slide 7 of 46 Industrial &Production Engineering Slide 8 of 46 Industrial &Production Engineering
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