A drilling machine that cost $320,000 is owned by Alpha Beta Oil, Inc. Salvage i

Question

A drilling machine that cost $320,000 is owned by Alpha Beta Oil, Inc. Salvage is estimated at $75,000. (a) Compare book values for MACRS and standard SL depreciation over a 7-year recovery period. (b) Explain how the estimated salvage is treated using MACRS
A drilling machine that cost $320,000 is owned by Alpha Beta Oil, Inc. Salvage is estimated at $75,000. (a) Compare book values for MACRS and standard SL depreciation over a 7-year recovery period. (b) Explain how the estimated salvage is treated using MACRS

Explanation / Answer

For a 7 year asset the depreciation is as following under MACRS:

Year

Rate of depreciation

Depreciation (320000 x Rate of depreciation)

Book value under MACRS

1

14.29%

45728

274272

2

24.49%

78368

195904

3

17.49%

55968

139936

4

12.49%

39968

99968

5

8.93%

28576

71392

6

8.92%

28544

42848

7

8.93%

28576

14272

Book value under SLM:

Year

Depreciation

Book value

1

35000

285000

2

35000

250000

3

35000

215000

4

35000

180000

5

35000

145000

6

35000

110000

7

35000

75000

Workings:

Depreciation under SLM

Cost of the machine

320000

Less: Salvage value

75000

Depreciable amount

245000

Useful life

7 years

Depreciation per year (245000/7)

35000

As can be seen that under MACRS the amount of depreciation charged to the machinery is relatively higher in initial years whereas in the later years of the machine’s useful life the amount However, the total amount of depreciation under MACRS is significantly higher than the amount of depreciation under SLM. As a result of this the book value under MACRS in each year is quite low compared to the book value under SLM.   

            In case of MACRS the amount of estimated salvage is treated as profit, i.e. excess amount of salvage value over and above the book value of the machine is credited in the profit and loss account of the company.

For a 7 year asset the depreciation is as following under MACRS:

Year

Rate of depreciation

Depreciation (320000 x Rate of depreciation)

Book value under MACRS

1

14.29%

45728

274272

2

24.49%

78368

195904

3

17.49%

55968

139936

4

12.49%

39968

99968

5

8.93%

28576

71392

6

8.92%

28544

42848

7

8.93%

28576

14272

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