Chapter 17
Depreciation
Student Performance Objectives:
Section I Traditional Depreciation – Methods Used for Financial Statement Reporting
17-1 Calculating Depreciation by the Straight-Line Method
Section II Asset Cost Recovery Systems – IRS Prescribed Methods for Income Tax
Reporting
17-5 Calculating Depreciation by Using the Modified Accelerated Cost Recovery System
Chapter Notes, Teaching Tips and Lecture Launchers
• Spotlight: Stress that this chapter, as with Chapters 15, Financial Statements, and Chapter
16, Inventory, has to do primarily with accounting and income tax procedures.
• Remind students that these chapters will serve as a very good review when they take
accounting.
• Students should also be reminded that although depreciation is primarily an accounting
procedure, it is important to understand the underlying “business sense” of the subject.
• Spotlight: Point out to students that buildings and other structures may depreciate, however
land does not.
• Remind students, a recap of all formulas used in the chapter is listed in the Chapter
Summary.
• Spotlight: The Collaborative Learning Activity at the end of this chapter, “Going, Going,
Gone!,” asks students to explore how various models of automobiles depreciate in today’s
material they have learned in the chapter.
• Spotlight: The Business Decision at the end of the chapter, “A Dispute with the IRS,” is a
scenario that illustrates how changing the property class of an asset under MACRS can affect
the bottom line of a company’s income statement as well as its balance sheet.
Section I Traditional Depreciation Methods Used for Financial Statement
Reporting
• Spotlight: Be sure students realize that straight-line, sum-of-the-years’ digits, and declining
balance methods of depreciation are based on time, whereas the units of production method
is based on productivity of an asset, regardless of time.
• Accelerated methods assume that an asset depreciates more in the early years of its
useful life.
• In the straight-line, sum-of-the-years digits, and units-of-production methods, be sure
students subtract the salvage value from the total cost of the asset to determine the total
amount to be depreciated.
• Spotlight: In the sum-of-the-years digits method, be sure students use the larger fraction
(highest denominator) in the first year, not the lowest. Remind them this is an “accelerated”
method, therefore the largest depreciation is taken first.
• Remind them also that the sum of all the fractions is 1.
• Stress that salvage value is not subtracted from total cost with the declining-balance method.
• Depreciation stops when book value equals salvage value.
• Have students keep in mind, the units-of-production method of depreciation is based on how
much a unit is used, such as in miles, hours, or units produced, rather than the passage of
time.
• Depreciation per unit =
Cost – Salvage value
Units of useful life
• Spotlight: When preparing a depreciation schedule, be sure students know:
• Starting book value equals the original cost of the asset.
• Remind students an asset cannot be depreciated below its salvage value or actual cost.
• A common mistake made by business owners is to continue depreciating an asset
beyond its recovery period.
Section II Asset Cost Recovery Systems:
IRS Prescribed Methods for Income Tax Reporting
• Point out that cost recovery allowance is the term used under MACRS for the amount of
depreciation of an asset that may be written off for tax purposes in a given year.
• Spotlight: Point out to students that in MACRS, the entire asset is depreciated. There is no
salvage value.
• Because salvage value and useful life don’t have to be estimated, MACRS is the least
complex method of depreciation.
• Use Table 17-1 to illustrate MACRS Property Classes and Table 17-2 to illustrate the
MACRS Cost Recovery Percentage Table.
• Call attention to the fact that although MACRS is used for calculating federal income tax,
most states “do not” allow this method to be used in the calculation of state income tax.
• Homework Assignment: Have students research whether your state has an income
tax, and what rules are in effect regarding asset depreciation.
Questions Students Always Ask
“How do I know how long an asset will last?”
• It’s not so much how long it will last, but it’s economic life we need to estimate. Since it
“Are there any assets that don’t have to be depreciated?”
• Yes. Tangible personal property (items that can be touched, like a computer, as opposed
to intangible items, like copyrights or shares of stock in a company that are merely
“What about items like computer software; can I depreciate any intangible assets?”
• Computer software may be depreciable if it’s bought “off-the-shelf” and not modified.
“What happens to the salvage value under MACRS?”
• Because the total cost of an asset is depreciated under MACRS, there is no salvage value