W14_UDS_Fuel Tank Truck Feasibility Study Part 2: Best Depreciation Method

  1. Problem Evaluation

Continue tank truck operation evaluation in blog posting W13, this time author want to research what the best depreciation is. The best mean give more benefit of Author Company such as minimize income tax and also give financial projection of tank truck operational cash flow.

  1. Development of feasible alternatives

There are four depreciation models that will compare to get best method:

  1. Straight Line Method
  2. Declining Balance Method
  3. Declining with switchover to Straight Line Method
  4. MACRS Method

 

  1. Development the outcome for each alternative

Those four method depreciation are choose to compare two group method, commonly use method such as  Straight Line Method and Declining Balance Method, and not commonly use such as Declining with switchover to Straight Line Method and MACRS Method. All method will be compare by depreciation value; bigger depreciation value will get lower income tax.

  1. Selection of criteria

The best method is the method that has the biggest depreciation value. Depreciation value is get from sum present worth of all year depreciation result of each method. 

  1. Analysis and comparison of the alternative

To simulate this depreciation comparison author will use 24 KL aluminum fuel tank truck data. Those data is in table below.

Table 1. Fuel Tank Truck Data

Next step is data calculating of each depreciation method, according to straight line method:

dk = (B – SVN) / N

dk* = k. dk for 1 ≤ k ≤ N

BVk = B – dk*

According to Declining Balance method:

d1 = B(R)

dk = B (1 – R)k-1 (R)

dk* = B (1 – (1 – R)k)

BVk = B (1-R)k

Where:

N               = depreciable life of the asset in years

B                = cost basis, including allowable adjustments

Dk             = annual depreciation deduction in year k (1 ≤ k ≤ N)

BVk           = book value at end of year k

SVN          = estimated salvage value at end of year N

dk*             = cumulative depreciation through year k

The calculation results of four depreciation methods are in table below:

Table 2. Straight Line Method

To demonstrate Declining Balance method, the author use 300% DB equations and result of calculation based on above equation is

Table 3. 300% Declining Balance Method

Method of Declining Balance Method Switchover to Straight Line Depreciation, in this method the first step is the asset would be depreciated by the 300% DB Method (R =3/N). Because the DB method never reach a zero BV, suppose that author further specify that at switchover to SL depreciation to will be made to ensure a BV of zero (determined salvage value).

Table 4. DB Method Switchover to SL Method

To determine the MACRS (GDS) with half year convention assumption and period of analysis in 6 years based on GDS property class.

Table 5. MACRS (GDS) Method, Using Half year convention

Table 6. PW(12) Comparison

Figure 1. PW(12) of each method

  1. Alternative selection

As can be seen above MACRS method have the largest PW(12) than other. We can conclude MACRS method is the best alternative that more attractive to profitable companies.

  1. Performance monitoring & Post Evaluation Result

To get the best result of method we have to find most appropriate model of depreciation. We should calculate PW of depreciation value of each method, because bigger PW of depreciation value will get lower income tax and more profit of our company.

References

  1. Sullivan, G. W., Wicks, M. E., & Koelling, C. P.(2014). Engineering economy 16th Edition. Chapter 7 – Depreciation and income tax., pp.332-391. Prentice Hall.
  2. Planning Planet. (2017). Acquiring Equipment For The Project. Retrieved from http://www.planningplanet.com/guild/gpccar/acquiring-equipment-for-the-project
  3. Accounting-Simplified.com (2017). Depreciation Methods. Retrieved from http://accounting-simplified.com/financial/fixed-assets/depreciation-methods/types.html
 

1 thought on “W14_UDS_Fuel Tank Truck Feasibility Study Part 2: Best Depreciation Method”

  1. Great case study Pak Dhanu!!

    Can you explain how cash flow analysis determines what is the best method to use for depreciation?

    What is the fundamental accounting principle that applies when looking at which method to adopt for any particular asset?

    Those are the kinds of questions you are going to see on the AACE and GPC ESSAY type question.

    BR,
    Dr. PDG, Jakarta

     

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