By Charles C. Ross
Depreciation--
Which method is best?
Part Two of a Three-Part Series
In the first article of this series on
depreciation (PM, Jan ., p .16) , the
most applicable methods of depreci-
ating amusement games were des-
cribed . The straight-line method
taking equal amounts of depreciation
each year , the sum-of-the -years
digits method and the declining-
balance method which take the
biggest amounts of depreciation in
the early years.
Which method do you use? The
equipment operator has an easy
solution to the problem . As brought
out in the first article the straight-line
method should not be used because
this method does not do a good job
of allocating depreciation so book
values are close to market values .
The straight-line method also was
recommended for equipment whose
productivity was roughly the same
Table 1
Depreciation Expe nses by Straight-Line,
Sum-o f-the -Y ears ' -Digits and Declining-Balance Methods
Machine Price
Factory Freight
Sales Tax 5 % of price
Freight From Distributor
~lachine ' s Cos t
$1395 . 00
35 . 00
69 . 75
20 . 25
$1520 . 00
Salvage Value :
$200 . 00
Straight-Line Depreciation
Cost - Salvage Value
L~fe
=
$1520 - $200
5
Depreciation Expense per year
$264
Sum-of-the-Years '- Digits
Years in
Useful Life
1
2
3
4
5
SYD IS
Fraction of
Total Depreciation
to be taken each year
5/15
4/15
3/15
2/15
1/15
x Depreciable
Cost
x
$1320
x
1320
x
1320
x
1320
x
1320
Annual
Depreciation
Allocation
$ 440
352
264
176
88
$1320
Declining - Balance
Year
1
2
3
4
5
Beginning
Factor
Book
x 2 times Straight-
Value
Line Rate
$1520
912
547
328
200
40 %
40 %
40 %
40 %
40 %
Annual
Deprecia tion
Expense
$ 608
365
219
128*
-0-
$1320
Remaining
Book
Value*
$ 912
547
328
200
200
* (Beginning Book Value - Depreciation Expense)
*($ 328 x . 4 = $131 , but by the declining-balance method
equipment cannot be depreciated below its salvage value ,
which is $200 in this case . )
6
throughout its useful life and equip-
ment whose obsolescense factor is
low . But amusement machines don 't
fall in that category either .
Therefore , the operator is left with
one of the more complicated meth-
ods to calculate, the sum·of·the-
years digits method or the declining-
balance method . Fortunately for the
equipment operator these two accel-
erated methods also give the best tax
advantages .
Before exploring the tax ad-
vantages of an accelerated deprecia·
tion method , study Table 1. It
reviews the various depreciation
calculations for a machine with a
five-year life , $1520 cost and a $200
salvage value .
It should be noted from Table 1
that the depreciation taken by all
three methods totals the same $1320
amount. The only difference is that
th e accelerated methods take larger
amounts of depreciation in the early
years and less depreciation in the
later years .
Table 2 isolates the impact of the
different depreciation methods on
income taxes paid over the life of the
machine . Table 2 also illustrates the
point that total taxes paid will be the
same under each method , so
wherein lies the advantage?
The tax advantage to an accele -
rated depreciation method comes
from th e postponing or deferring of
income tax to a later year and not
escaping the payment of income tax ,
as is often misconstrued . As Table 2
clearly shows , regardless of the
depreciation method employed , the
total taxes paid will be the same , but
the amount paid each year under the
various methods is different.
To see the advantage of an
accelerated method , you must un -
derstand the time value of money .
Money is worth more today than it
will be in the future because of
investment
opportunities
which
would generate income , and because
of that monster which distorts our
economy - inflation . A dollar will not
buy next year what a dollar will buy
today because of price increases .
PLAY METER , February, 1979