Methods of depreciation

Straight-line Depreciation The simplest and most commonly used method, straight-line depreciation is calculated by taking the purchase or acquisition price of an asset, subtracting the salvage value (value at which it can be sold once the company no longer needs it) and dividing by the total productive years for which the asset can reasonably be expected to benefit the company (or its useful life). Example: For $2 million, Company ABC purchased a machine that will have an estimated useful life of five years. The company also estimates that in five years, the company will be able to sell it for $200,000 for scrap parts. Depreciation Expense = Total Acquisition Cost Salvage Value / Useful Life

Straight-line depreciation produces a constant depreciation expense. At the end of the asset's useful life, the asset is accounted for in the balance sheet at its salvage value. Accelerated Depreciation Accelerated depreciation allows companies to write off their assets faster in earlier years than the straight-line depreciation method and to write off a smaller amount in the later years. The major benefit of using this method is the tax shield it provides. Companies with a large tax burden might like to use the accelerated-depreciation method, even if it reduces the income shown on the financial statement. This depreciation method is popular for writing off equipment that might be replaced before the end of its useful life if it becomes obsolete ( computers, for example). Companies that have used accelerated depreciation will declare fewer earnings in the beginning years and will seem more profitable in the later years. Companies that will be raising financing (via an IPO or venture capital) are more likely to use accelerated depreciation in the first years of operation and raise financing in the later years to create the illusion of increased profitability (and therefore higher valuation).

The two most common accelerated-depreciation methods are the sum-of-year (SYD) method and double-declining-balance method (DDB): Sum-of-Year Method: Depreciation In Year i = ((n-i+1) / n!) * (total acquisition cost - salvage value) Example: For $2 million, Company ABC purchased a machine that will have an estimated useful life of five years. The company also estimates that in five years, the company will be able to sell it for $200,000 for scrap parts. n! = 1+2+3+4+5 = 15 n=5

[Example, Straight line depreciation] On April 1, 2011, Company A purchased equipment at the cost of $140,000. This equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value (residual value) will be $20,000. Company A recognizes depreciation to the nearest whole month. Calculate the depreciation expenses for 2011, 2012 and 2013 using straight line depreciation method. Depreciation for 2011 = ($140,000 - $20,000) x 1/5 x 9/12 = $18,000 Depreciation for 2012 = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000 Depreciation for 2013 = ($140,000 - $20,000) x 1/5 x 12/12 = $24,000

The sum-of-year depreciation method produces a variable depreciation expense. At the end of the useful life of the asset, its accumulated depreciation is equal to the accumulated depreciation under the straight-line depreciation. Double-Declining-Balance Method The DDB method simply doubles the straight-line depreciation amount that is taken in the first year, and then that same percentage is applied to the un-depreciated amount in subsequent years. DDB In year i = (2 / n) * (total acquisition cost - accumulated depreciation) n = number of years Example For $2 million, Company ABC purchased a machine that will have an estimated useful life of five years. The company also estimates that in five years the company will be able to sell it for $200,000 for scrap parts.

[Example, Double declining balance depreciation] On April 1, 2011, Company A purchased an equipment at the cost of $140,000. This equipment is estimated to have 5 year useful life. At the end of the 5th year, the salvage value (residual value) will be $20,000. Company A recognizes depreciation to the nearest whole month. Calculate the depreciation expenses for 2011, 2012 and 2013 using double declining balance depreciation method. Useful life = 5 years --> Straight line depreciation rate = 1/5 = 20% per year Depreciation rate for double declining balance method = 20% x 200% = 20% x 2 = 40% per year Depreciation for 2011 = $140,000 x 40% x 9/12 = $42,000

Depreciation for 2012 = ($140,000 - $42,000) x 40% x 12/12 = $39,200 Depreciation for 2013 = ($140,000 - $42,000 - $39,200) x 40% x 12/12 = $23,520

Double Declining Balance Depreciation Method

Year 2011 2012 2013 2014 2015

Book Value Depreciation Rate at the beginning $140,000 40% $98,000 40% $58,800 40% $35,280 40% $21,168 40%

Depreciation Expense $42,000 (*1) $39,200 (*2) $23,520 (*3) $14,112 (*4) $1,168 (*5)

Book Value at the year-end $98,000 $58,800 $35,280 $21,168 $20,000

(*1) $140,000 x 40% x 9/12 = $42,000 (*2) $98,000 x 40% x 12/12 = $39,200 (*3) $58,800 x 40% x 12/12 = $23,520 (*4) $35,280 x 40% x 12/12 = $14,112 (*5) $21,168 x 40% x 12/12 = $8,467 --> Depreciation for 2015 is $1,168 to keep book value same as salvage value. --> $21,168 - $20,000 = $1,168 (At this point, depreciation stops.)

The double-declining-balance method produces a very aggressive depreciation schedule. The asset cannot be depreciated beyond its salvage value. Unit-of-Production Depreciation This method provides for depreciation by means of a fixed rate per unit of production. Under this method, one must first determine the cost per one production unit and then multiply that cost per unit with the total number of units the company produced within an accounting period to determine its depreciation expense. Depreciation Expense = Total Acquisition Cost - Salvage Value / Estimated Total Units Estimated total units = the total units this machine can produce over its lifetime Depreciation expense = depreciation per unit * number of units produced during an accounting period

Example: Company ABC purchased a machine for $2 million that can produce 300,000 products over its useful life. The company estimates that this machine has a salvage value of $200,000.

Unit-of-production depreciation produces a variable depreciation expense and is more reflective of production-to-cost (see matching principle). At the end of its useful life, the asset's accumulated depreciation is equal to its total cost minus its salvage value. Furthermore, its accumulated production units equal the total estimated production capacity. One of the drawbacks of this method is that if the units of products decrease (due to slowing demand for the product, for example), the depreciation expense also decreases. This results in an overstatement of reported income and asset value. Maximum Amount Method Maximum Amount Method- SPRO> IMG> Financial Accounting (New)> Asset Accounting>Depreciation> Valuation Methods> Depreciation Key> Calculation Methods> Define Maximum Amount Method Generally, If we uses Straight line method, then depreciation amount should be same for all years. But depreciation on asset is subject to change due to many factors e.g. any addition to the asset, change in estimate of useful life, change in estimate of scrap value etc. So for maintaining better control on the amount of depreciation, SAP has provided this method where we can specify the maximum amount that can be charged as expense in a particular year. If this is specified, user will not be able to post depreciation exceeding the amount specified here.

MACRS Under MACRS, the capitalized cost (basis) of tangible property is recovered by annual deductions for depreciation over a specified life. The lives are specified in the Internal Revenue Service's (IRS) Tax Co de. The IRS publishes detailed tables of asset lives by asset class. The

deduction for depreciation is computed under one of two methods (declining balance switched to straight line or only straight line ) at the election of the taxpayer. Certain limitations may apply.

The following discusses about the major industries in India and also major export industry: LIST OF MAJOR INDUSTRIES IN INDIA Textiles The Indian textile industry covers a wide gamut of activities. Its production ranges from raw materials such as cotton, jute, silk and wool to high value-added products like fabrics and garments to consumers. The industry make use of different varieties of fibers, be it natural fibers, manmade fibers or blends of such fibers. In Indian economy, the textile industry plays a significant role. It provides direct employment to approximately 35 million people and contributes 4 per cent of GDP. It fetches 35 per cent of gross export earnings and contributes 14 per cent of the value-addition in the manufacturing sector. Chemicals The chemical industry in India is one of the oldest domestic industries and it currently produces nearly 70,000 commercial products, from cosmetics and toiletries, to plastics and pesticides. The country is the 13th largest exporter of pesticides and disinfectants globally. In terms of volume, it figures 12th largest producer of chemicals. The petrochemical, agrochemical, and pharmaceutical industries are some of the fastest growing sectors in the Indian economy. The estimated worth of chemical industry is $28 billion and it accounts for 12.5 per cent of the total industrial production of India and 16.2 per cent of the its total exports. Food Processing India is one of the major food producing country in the world but accounts less than 1.5 per cent of international food trade. Hence, there is a vast scope for the expansion of this industry. The food processing industry is estimated (2004) at Rs 3,150 bn (US$ 70 bn), including value added products of Rs 990 bn (US$ 22bn). The estimated growth of this industry is 9-12% and on the basis of estimated GDP, the growth rate is 6-8%, during the tenth plan period. The industry employs 1.6 mn workers and it is projected to grow to 37 mn, direct and indirect, by 2025. Steel The 4000 years Indian steel industry is on the upswing. During April-December 2004-05, the production of the finished steed recorded a growth of 4 per cent and reached 28.3 million tonnes. In the world scenario, Indian steel industry ranks 10th. It represents approximately Rs. 9,000 crore of capital and provides direct employment to more than 0.5 million people.

Major Players: Steel Authority of India (SAIL), Bhilai Steel Plant, Durgapur Steel Plant, Rourkela Steel Plant, Bokaro Steel Plant. Cement Cement industry in India comprises of 125 large cement plants and over 300 mini cement plants having total installed capacity of 148.28 million tonnes and 11.10 million tonnes per annum respectively. In addition to this, there are 10 large cement plants owned by various State Governments. So, the total installed capacity of the country as a whole stands at 159.38 million tonnes. The export of cement in 2003-04 was 6.92 million tonnes. Major Players: Ambuja cement, Aditya Cement, J K Cement and L & T Cement. Mining The mining industries share in India's GDP is from 2.2% to 2/5% only but it contributes to 1011% in industrial sector's GDP. The organized mining sector employs nearly 0.7 million people. Small scale mining approximately contributes to 6% of the total value of mineral production. Petroleum The petroleum industry in India is one of the oldest industries in the world, with oil being struck as early as 1867 at Makum near Margherita in Assam, nine years after Coll. Drake's discovery in Titusville. Since then the industry has come a long way. Today, after over fifty years of independence, the oil sector has seen the growth of giant national companies, like ONGC. India represents one of the most exciting oil markets in the world today. Major Players in integrated refining and marketing are HPCL, BPCL and IOC. Software The software industry in India symbolizes India's strength in the knowledge based economy. It has witnessed a phenomenal growth in last decade. The Compounded Annual Growth Rate (CAGR) is 42.3%. According to NASSCOM's projection, the software industries contribution is expected to grow to 7% by 2008 which started with 0.59% in 1994-95 and reached to 2.87% by 2001-02.