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to use a 2 or 3 year “useful life” in its accounting to be able to count more money as expenses
against earnings this year (and thus to keep its income tax liability lower.)
On the other hand, if the company is trying to make itself look as profi table as possible
to convince outside investors or potential buyers of the business to place a higher value on
the business, the company may want to minimize depreciation to keep the expenses shown
on their books as low as possible. A 10- or 15-year or even longer useful life might be
desirable in that case so as to make the depreciation expense in each year small and make
profi ts seem larger.
It does not seem quite right that a company could game its annual profi ts by choosing a
useful life for a depreciating asset based entirely on how it wants its profi ts to look. Fortu-
nately, professional accounting standards put reasonable limits on how quickly items can
be depreciated, as do Internal Revenue Service regulations (though the two do not always
agree, and this may require a business to have two different calculations of its annual
profi ts). While a business’s accountants do not have free rein in how long to set the useful
life for an asset, it is nonetheless true that the useful life for depreciation purposes may be
different (usually shorter) than the length of time that the business can realistically expect
the item in question to be useful.
More surprisingly, accounting principles may require a business to depreciate for
accounting purposes an item that is not even expected to actually lose value. People who
own rental real estate, for example, in their accounting often depreciate the real estate that
they own, treating the purchase price of the real estate as an expense to count against the
income that they get in rent. This fl ies in the face of the fact that in reality the real estate
will hopefully actually grow in value over time. This may seem strange, but remember that
in such cases depreciation is a matter of accounting for a business’s costs, not an attempt to
assign a realistic market value to the property.
Before moving on, we should note one apparent difference between straight-line and
percent depreciation. It may appear from this example that salvage values are used only
with straight-line depreciation, not with percent depreciation. While it is true that salvage
values are more commonly encountered with straight line, it is possible to have a salvage
value with percent depreciation. We will not, however, deal with that situation in this text.MACRS and Other Depreciation Models
Straight-line and percent depreciation are commonly used methods of calculating depre-
ciation, but there are others. Probably the best known is the Modifi ed Accelerated Cost
Recovery System (MACRS). MACRS (the acronym is pronounced like “mackers”) was
put into use in the United States under the Tax Reform Act of 1986. Generally speaking, its
purpose was to allow businesses to claim larger depreciation expenses early on than would
have been permitted by straight-line depreciation. MACRS is widely used for the purpose
of computing taxable income in the United States.
The formulas on which MACRS is based are seldom seen in practice. Instead, account-
ants use tables. Each type of depreciable item is assigned a MACRS useful life (which may
or may not match up with its realistic useful life), and then a certain percent of deprecia-
tion is allowed each year. This percent normally applies to the entire acquisition price of
the item; the residual value is taken to be zero, regardless of whether or not the item really
could be expected to have no actual residual value.
For example, under MACRS computers are usually depreciated over 5 years. The per-
cents used for this equipment under MACRS each year are:Year Percent1 20%
2 32%
3 19.2%
4 11.52%
5 11.52%
6 5.76%8.4 Depreciation 369