# Farm Management

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18 Νοε 2013 (πριν από 4 χρόνια και 6 μήνες)

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Farm Management

Chapter 4

Depreciation and Asset Valuation

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Chapter Outline

Depreciation

Depreciation Methods

Income Tax Depreciation

Valuation of Assets

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Chapter Objectives

1.
To define depreciation and related terms

2.
To illustrate the different methods of
computing depreciation

3.
To compare economic and income tax
depreciation

4.
To outline the different methods that can
be used to value farm and ranch assets

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Depreciation

Defined as the annual loss in value of
durable assets due to use, wear, tear, age,
and obsolescence

A business expense that reduces annual
profit

A reduction in the value of an asset

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Assets that May Be Depreciated

a useful life of more than one year

a determinable useful life but not an
unlimited life

a use in business

Examples: vehicles, machinery, equipment,

building, fences, purchased breeding livestock,

wells. Land is not depreciable, but some

improvements to land (e.g. drains) are depreciable.

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Depreciation Terms

Cost
: the price paid for the asset

Useful life
: number of years the asset is
expected to be used in business

Salvage value
: expected market value of
the asset at the end of its useful life

Book value
: the asset’s original cost less
accumulated depreciation

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Depreciation Methods

Straight Line

Sum
-
of
-
the
-
Year’s Digits (SOYD)

Declining Balance

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Straight Line

Annual Depreciation

=

Cost

Salvage Value

Useful Life

Annual Depreciation = (Cost

Salvage Value) x R

where R is found by dividing 100% by useful

life

Or

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Sum
-
of
-
the
-
Year’s Digits

Annual Depreciation

=
(Cost

Salvage Value)

x

RL = remaining years of useful life

SOYD = sum of all the numbers from 1 through

the estimated useful life

For 5 year life, SOYD = 1+2+3+4+5 = 15

RL

SOYD

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Declining Balance

Annual Depreciation =

Beginning Year Book Value x R

R is a constant percentage rate. Its value

depends on useful life and the type of

declining balance chosen. It is a multiple

of the straight line rate.

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Examples

Calculate depreciation for a machine with

a cost of \$10,000, a salvage value of \$2,000,

and a useful life of 10 years.

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Using Straight Line

Annual Depreciation =

(\$10,000

\$2,000)

10

= \$800

Annual depreciation will be the same every year

under this method.

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Using SOYD

1+2+3+4+5+6+7+8+9+10 = 55

Year 1: (\$10,000

\$2,000) x = \$1,454.55

10

55

Year 2: (\$10,000

\$2,000) x = \$1,309.09

9

55

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Using Double Declining Balance

Year 1: \$10,000 x 20% = \$2,000

Year 2: \$ 8,000 x 20% = \$1,600

Year 3: \$ 6,400 x 20% = \$1,280

20% = 2 x

100%

10

useful life

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Using 150% Declining Balance

Year 1: \$10,000 x 15% = \$1,500

Year 2: \$ 8,000 x 15% = \$1,275

Year 3: \$ 6,400 x 15% = \$1,084

15% = 1.5 x

100%

10

useful life

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When Using Declining Balance

If there is a salvage value greater than zero,
declining balance methods can result in the
salvage value being reached before the end
of the useful life. Depreciation must stop
when book value = salvage value.

If salvage value is zero, it is necessary to
switch from declining balance to straight line
(on the remaining value and remaining life) at
some point to get all the depreciation
allowed.

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Partial Year Depreciation

If an asset is purchased during the year,

rather than at the beginning of the year,

depreciation must be prorated. A tractor

purchased April 1 would be eligible for

9/12 of a full year’s depreciation the

first year.

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Figure 4
-
1

Three depreciation methods

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Income Tax Depreciation

Must be done following rules of IRS

Modified Accelerated Cost Recovery
System (MACRS)

An implied salvage value of 0

Half year depreciation in year of purchase,
regardless of when purchased

Property classes determine useful life of
property

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Asset classes

3
-
year: breeding hogs

5
-
year: cars, pickups, breeding cattle and
sheep, dairy cattle, computers, trucks

7
-
year: most farm machinery and
equipment, fences, grain bins, silos, office
furniture

10
-
year: single purpose ag/hort structures

15
-
year: wells, paved lots, drainage tiles

20
-
year: general purpose buildings

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Table 4
-
1

MACRS Recovery Rates

Recovery
3-year
5-year
7-year
Year
class
class
class
1
25.00
15.00
10.714
2
37.50
25.50
19.133
3
25.00
17.85
15.033
4
12.50
16.66
12.249
5
16.66
12.249
6
8.33
12.249
7
12.249
8
6.124
Recovery Precentages
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Economic vs. Tax Depreciation

Economic depreciation is linked to asset’s
reduced ability to produce revenue as it ages
and wears out.

Tax depreciation is the allowable business
expense for IRS purposes. It may or may not
be close to the economic depreciation.

It may be advisable for managers to devise
two depreciation schedules, one for tax
purposes and one for business analysis.

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Table 4
-
2

Depreciation Schedule

Cost
Depre-
Date
or
Salvage
ciation
Depre-
Book
Depre-
Book
Depre-
Book
Item
Purchased
Basis
Value
Life
method
ciation
value
ciation
value
ciation
value
20______
20_____
20_____
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Valuation of Assets

Market Value
: fair market price less any
transactions cost (for items normally sold)

Cost
: for purchased items that do not
normally lose value

Lower of cost or market
: conservative
method

Farm production cost
: accumulated cost of
producing the item (immature crops growing
in field, livestock)

Cost less accumulated depreciation
: book
value. For items that depreciate

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Summary

A depreciation schedule is a necessary part

of any accounting system. Depreciation is

an expense used to calculate profit, and

depreciation reduces the value of assets.

Depreciation used for tax purposes may differ

from economic depreciation and managers
may need to calculate both. Valuation
methods for business assets were

also discussed
.