An asset for drilling was purchased and placed in service by a petroleum product
ID: 2548354 • Letter: A
Question
An asset for drilling was purchased and placed in service by a petroleum production company. Its cost basis is $60,000, and it has an estimated MV of $14,000 at the end of an estimated useful life of 13 years. Compute the depreciation amount in the third year and the BV at the end of the sixth year of life by each of these methods a. The SL method. b. The 200% DB method with switchover to SL. c. The GDS. d. The ADS. Click the icon to view the partial listing of depreciable assets used in business. Click the icon to view the GDS Recovery Rates (k)Explanation / Answer
A) Straight line depreciation method charges cost evenly throughout the useful life of a fixed asset.
This depreciation method is appropriate where economic benefits from an asset are expected to be realized evenly over its useful life.
Straight line method is also convenient to use where no reliable estimate can be made regarding the pattern of economic benefits expected to be derived over an asset's useful life.
Straight line depreciation can be calculated using any of the following formulas:
Depreciation per annum
=
( Cost Residual Value )
Useful Life
Depreciation per annum
=
( Cost Residual Value ) x Rate of depreciation
Depreciation per annum = $60,000
13
= $ 4615.00
Annual depreciation is calculated as the cost of an asset divided by its useful life. In this case, the machinery was purchased for $60000 and has a useful life of 13 years. Thus, the annual amount of depreciation should be $4615.00 . The Depreciation amount of third year is $ 4615.00 According the straight line method.
B) THE 200 DB METHOD WITH SWITCHOVER TO SL EXAMPLE
Switching takes place when depreciation amount of an asset for a given year in the present depreciation method is less than that in the new depreciation method. The most commonly used switching is from declining balance ( DB) method to straight-line (SL) method. In declining balance method, the book value as calculated by using equation never reaches zero. In addition the calculated book value at the end of useful life does not match with the salvage value. Switching from declining balance method to straight-line method ensures that the book value does not fall below the estimated salvage value of the asset.
Initial cost of the asset = P = $60000.00
Useful life = n = 13 years
Salvage value = SV = 0
For declining balance method, the constant annual depreciation rate ‘dm' is given by;
Dm = 2
n
Dm = 2
13
=0.1538
The annual depreciation and the book value at the end different years are calculated using the respective equations stated earlier and are presented in Table
Table
Depreciation and book value from declining balance method
Year
Depreciation
Book Value
0
-
60000
1
9228
50772
2
7809
42963
3
6608
36355
4
5591
30763
5
4731
26032
6
4003
22028
7
3387
18640
8
2866
15773
9
2426
13347
10
2052
11294
11
1737
9556
12
1469
8086
13
1243
6842
declining balance method and switching to straight-line method.
Year
Depreciation amount (DB method)
Depreciation amount (DB method)
0
-
4615
1
9228
4615
2
7809
4615
3
6608
4615
4
5591
4615
5
4731
4615
6
4003
4615
7
3387
4615
8
2866
4615
9
2426
4615
10
2052
4615
11
1737
4615
12
1469
4615
13
1243
4615
C) The percentage of your income to pay monthly income to housing costs, including interest, taxes and principal. It is also include 50% of your fees, if applicable. The majority of lenders by a general standard, so your GDS should be lower than qualify loan mortgage.
For calculation of GDS ration you will need to add all your monthly income like housing related costs and divide it to your gross monthly income after that multiply that sum by 100. It will be GDS ratio.
D) ADS
Alternative depreciation system is depreciation schedule which is used for longer recovery period. It is applied to all property of the same class placed in service during the same year. Taxpayer used ADS method will allow for better match depreciation deduction against income than the period under GDS. If the taxpayer chosen ADS method the taxpayer cannot be revert back. The ADS system recovery is listed in IRS publication 946.
Depreciation per annum
=
( Cost Residual Value )
Useful Life
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