Engineering Economic Analysis

1

356 DEPRECIATION

$150,000

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..........

'."'" .., , ". .,." ,...

$125,000

«) $100,000:::I

~

~o $75,000

o

I:Q $50,000

$25,000

o 2 4 6 8 10

Year,t

FIGURE 11-5 Comparing MACRS ( ) and historical depreciation methods: double declining

balance ( 4. ), sum of the years' digits (_ _ _ _ _), and straight line ( ; )

Depreciation and Asset Disposal

When a depreciated asset is disposed of, the key question is, Which is larger, the asset's

book value, BV(what we show in our accounting records after applying the rules set by the

government) or the asset'smarket value, MV(what a willing buyer pays)? If the bookvalue

is lower than the market value, then too much depreciationhas been deducted from taxable

income. On the other hand, if the book value is higher than the market value, there is aloss

on the disposal. In either case, the current level of taxes owed changes.

Depreciation recapture(ordinarygains): Depreciation recapture, also called ordinary

gains, is necessarywhen an asset is sold for morethan an asset's current book value.

If more than the original cost basis is received, only the amount up to the original

cost basis is recaptured depreciation. Ordinary gains are also calleddepreciation

recapturebecause the amount of gain represents the overexpense in depreciation

that has been claimed.In other words, we've taken too much expense for the asset's

"loss in value."Since MACRSassumes S = 0 for its annual calculations, MACRS

often has recaptured depreciation at disposal.

Losses:Alossoccurs when less than book value is received for a depreciated asset.

In the accounting records we've disposed of an asset for a dollar amount less than

its book value, which is a loss. In this case a company has not claimed enough

depreciation expense.

Capital gains: Capital gains occur when more than the asset's original cost basis is

received for it. The excess over the original cost basis is thecapital gain.As

described in Chapter 12, the tax rate on such gains is sometimes lower than the

rate on ordinary income, but this depends on how long the investment has been

held ("short," ::: 18 months; "long," ~ 18 months). In most engineering economic