- Problem Definition
As NOC, storage tank is our main asset. We plan to build a 10.000 Kl storage tank, it will cost $ 1.300.000. The asset will be used for 20 years, and the SV at the end of useful life is $ 65.000.
In this week blog posting, Author wants to know the best depreciation method for the company, in order to reduce our income tax.
- Development of Feasible Alternatives
Alternatives for depreciation method are:
- Option 1 : Straight Line (SL) method
- Option 2 : Declining-Balance (DB) method
- Option 3 : DB with Switchover to SL Depreciation
- Option 4 : Sum of the Year Digits (SYD) method
- Option 5 : Modified Accelerated Cost Recovery System (MACRS)
3. Possible Solution
Option 1: SL Method
In this method, we assumes a constant amount is depreciated each year over the useful life of the asset.
Table 1 : SL Method
Option 2: DB Method Using 150% DB Equations
DB Method assumes the annual cost of depreciation is fix percentage of the BV at the beginning of the year.
Table 2: DB Method
Option 3: DB with Switchover to SL Depreciation
DB with Switch over to SL Depreciation assumes that the DB Method never reaches a BV of zero; it is permissible to switch from DB to the SL method so that an asset’s BV will be zero (or some other determined amount such as its SV at year k).
Table 3: DB with Switchover to SL
Option 4: Sum of the Year Digits (SYD) method
SYD methods assume that assets are generally more productive when they are new and their productivity decreases as they become old.
Table 4: SYD Method
Option 5: MACRS Method
MACRS is unique to the United States Tax Code. Depreciation rates are set by percentages allowed under the U.S. Tax Code.
Based on IRS Publication 946 table B-2, Storage Tank class life is 14 years, and GDS 7 years.
Table 5: MACRS Method
- Selection Criteria
Our selection criteria will be the depreciation method that have the biggest impact on reduce taxable income for company.
- Analysis and Comparison of the Alternatives
Table 6: Comparison of Depreciation Method
Table 6 shows that the MACRS Method results in a larger share of the depreciation being charged during the earlier years of the asset’s life than others depreciation method.
- Selection and Preferred Alternatives
Figure 1: Depreciation Comparison
Depreciation expense will reduce company’s taxable earnings. The larger depreciation expense, the lower taxable income. Those will lower company’s tax payment.
As shown in figure 1, MACRS method generate the biggest depreciation in early years. Therefore, this method will generate the lower taxable income for company.
- Performance Monitoring and the Post Evaluation of Result
MACRS method is unique to US Tax code. For Indonesian company, we must exclude MACRS method from our analysis, and use the acceptable depreciation method that follow Tax system in Indonesia.
- Sullivan, William G., Wicks, Elin M. & Koelling, C. Patrick. (2014). Engineering Economy 16th edition Chapter 7 page 332 – 354, England: Pearson Education Limited.
- Module 06-5 Acquiring Equipment for the Project.
Retrieved from http://www.planningplanet.com/guild/gpccar/acquiring-equipment-for-the-project
- Publication 946 : How to Depreciate Property (2016)
Retrieved from https://www.irs.gov/pub/irs-pdf/p946.pdf
- W18_RM_Comparison of Depreciation Methods (2016)
Retrieved from https://goldenaace2015.wordpress.com/2016/05/13/w18_rm_comparison-of-depreciation-methods/