Sports EX Inc. is a Sports Shoes Company which is considering investing in a new

Question

Sports EX Inc. is a Sports Shoes Company which is considering investing in a new equipment for the production of a new line of Tennis and Football Shoes for its elite customers. The new equipment will costs $250,000, and an additional $80,000 is needed for installation. The equipment which falls into the MACRS 3-yr class, would be sold after three years for $35,000. (Hint: Since, this equipment will not be fully depreciated, because it is sold in year 3, you ignore the last tranche of the depreciation structure.)

Explanation / Answer

MACRS stands for modified accelerated cost recovery system. It is the current system allowed in the United States to calculate tax deductions on account of depreciation for depreciable assets (other than intangible assets). IRS Form 4562 is used to claim depreciation deduction.

It allows a larger deduction in early years and lower deductions in later years when compared to the straight-line method.

There are two sub-system of MACRS: the general depreciation system (GDS) and alternate depreciation system (ADS). GDS is the most relevant and is used for most assets.

Formulas

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MACRS

MACRS stands for modified accelerated cost recovery system. It is the current system allowed in the United States to calculate tax deductions on account of depreciation for depreciable assets (other than intangible assets). IRS Form 4562 is used to claim depreciation deduction.

It allows a larger deduction in early years and lower deductions in later years when compared to the straight-line method.

There are two sub-system of MACRS: the general depreciation system (GDS) and alternate depreciation system (ADS). GDS is the most relevant and is used for most assets.

Formulas

Where,
A is 100% or 150% or 200%.

However, where the depreciation calculated using the above formula is lower than depreciation under straight line method, the straight line depreciation for the previous year is taken as the relevant depreciation deduction for the rest of the recovery period.

Alternatively, tables provided by IRS can be used. Following table (taken from IRS website) shows rates for 200% declining balance method using half-year convention:

Steps in Calculation

Calculating depreciation under MACRS involves the following steps:

Depreciation in Year 1 :-

($250000+ $80000) X 33.33% = $ 110000

Depreciation in year 2 :-

$ 330000 X 44.45% = $ 146685

Depreciation in Year 3 :-

$ 330000 X 14.81% = $ 48873

Book value after year 3 = $ 330000-$110000-$146685-$48873 = $ 24442

Sale value after 3 years = $ 35000

Profit on the sale of asset after 3 year = $ 35000- $ 24442 = $10558

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