Engineering Economic Analysis

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Basic Aspects of Depreciation 341

capital improvements, and leased property. The leased property exception highlights the

fact that only the owner of property may claim depreciation expenses.

Tangible properties used inbothbusiness and personal activities, such as a vehicle

used in a consulting engineering firm that is also used to take one's kids to school, can be

depreciated.However,in such cases one can take depreciation deductionsonly in proportion

to the use for business purposes. Accurate records indicating the portion of use for business

and personal activities are required.

Depreciation Calculation Fundamentals

To understand the complexities of depreciation,the first step is to examine the fundamentals

of depreciation calculations. Figure 11-1 illustrates the general depreciation problem of

allocating the total depreciation charges over the asset's life. The vertical axis is labeled

book value, and the curve of asset cost or basis minus depreciation charges made starts at

the first cost and declines to the salvage value,

Book value = Asset cost - Depreciation charges made to date

Looked at another way, book value is the asset's remaining unallocated cost.

In Figure 11-1,book valuegoes from a value ofBat time zero in the recovery period to

a value of S at the end of Year5. Thus, book value is adynamicvariable that changes over

an asset's recoveryperiod. The equation used to calculate an asset's book value overtime is:

t

BV, =Cost basis - Ldj

j=l

(11-1)

where B \l,=book value of the depreciated asset at the end of timet

Cost basis=B =dollar amount that is being depreciated; this includes the asset's

purchase price as well as any other costs necessary to make the asset

"ready for use"

t.

Ldj=sum of depreciation deductions taken from time 0 to timet,wheredj

j=l is the depreciation deduction in Yearj

FIGURE 11-1 General

depreciation.

Cost

B

~ T

", TotalDepreciation

", Charges

,,

,

" CurveValuesDependon

", ,DepreciationMethod

,,

,,

,,

'.........

S

~

I

Salvage

Value

o

I

1 234

UsefulLife (years)

5

1