Question

DE 3 year 1 4 year 2 5 year 3 6 year 4 7 year 5 8 Total DDB over 5 years (not tax) 40.00% 24.00% 14.40% 8.64% 12.96% 100.00% End of year basis 60.00% 36.00% 21.60% 12.96% 0.00% MACRS 5 year year1 year 2 year 3 year 4 year 5 Year 6 Total Enter annual depreciation percentage Half of DDB Year 1 20.0% DDB average years 1,2 32.0% DDB average years 2,3 19.2% 11.5% 11.5% 5.8% 100.0% End of year basis 80.0% 48.0% 28.8% 17.3% 5.8% 0.0% 9

Look at the numbers calculated in the yellow field. In plain english please,

1.explain how depreciation was calculated for years 1-3.

2.explain how depreciation was calculating for years 4-6. Hint: End-of-year basis for year 3 is 28.8% divided by 5 = 5.8% Explain why divide by 5?

Answer 1

(1)	There are two types of MACRS Depreciation method a) Half year convention b) Mid quarter convention The given example is of Half year convention. It means that it is assumed that all additions are made at mid of the year irrespective of actual date of purchase of assets. for example if you purchase an asset on 10th jan, under half year convention method it will be assumed that you have purchased the asset on mid of year i.e. July 01.
	Hence, Depreciation for an asset whose useful life is 5 years, depreciation calculation will spread in 6 years.
	Under MACRS depreciation depreciation is calculated at double declining balance method for certain class of asset for half of the useful life of the asset. Then same is switched to straight line method. In the given example 200% i.e. double declining balance method has been used.
	Rate of depreciation under double declining method = 1/useful life*100*2 = 40%
	Since it is half year convention half of the depreciation calculated above (40%) will be charged in the first year of asset acquisition.
	Particulars	Annual depreciation %	Calculation	End of year basis	Calculation
	Half of DDB Year 1.	20%	(40%/2)	80%	(100%-20%)
	DDB average years 1,2	32%	(80%*40%)	48%	(80%-40%)
	DDB average years 2,3	19.2%	(48%*40%)	28.8%	(48%-19.2%)
		11.5%	(28.80%/5)*2	17.3%	(28.8%-11.5%)
		11.5%	(28.80%/5)*2	5.8%	(28.8%-11.5%)
		5.8%
(2)	At the end of 3rd year, 2.5 years life of the asset has been expired(since at end of first year only 0.5years depreciation was charged as per Half year convention rule).
	Hence, 50% of life of useful asset has been expired. Now it's time to switch in Straight line method. Basis at the end of 3rd year is = 28.80% This is to be allocated on straight line basis over remaining useful life i.e. 2.5 Years
	Remaining useful life of the asset at end of 3rd year basis is 2.5 Years or else we can say 5 half years.(2.5 years *2)
	Hence, Depreciation on straight line basis for 0.5 years = 28.80%/5 = 5.76% of 5.80%
	Hence, depreciation for year 4 (consisting 2 half years) will be = 5.76%*2 = 11.5%
	Hence, depreciation for year 5 (consisting 2 half years) will be = 5.76%*2 = 11.5%
	Hence, depreciation for year 6 (consisting 1 half year) will be = 5.76% i.e. 5.80%

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