Depreciation Methods
listed for informational purposes only

Depreciation Methods in Sage FAS 50 Asset Accounting and Sage FAS 100 and 500 Asset Accounting.

---------------------------------------------------------------------------------

MACRS

The Tax Reform Act of 1986 created a number of changes in the way depreciation is calculated for all assets acquired after December 31, 1986. This tax act made significant changes to the earlier Accelerated Cost Recovery System (ACRS), and created the modified ACRS (MACRS).

Recovery periods were generally extended. The typical recovery period for most personal property increased from 5 to 7 years, using 27.5 years for residential real property and 31.5 years for nonresidential real property. (The Revenue Reconciliation Act of 1993 extended the life of nonresidential real property placed in service after May 12, 1993, to 39 years.) A 200% declining-balance MACRS formula replaced the 150% declining-balance ACRS tables. The recovery rate for real property also fell from 175% declining-balance to a straight-line computation in MACRS.

The MACRS methods created by the Tax Reform Act of 1986 are mandatory for most tangible property placed in service after December 31, 1986. Taxpayers could also choose to use MACRS for certain transitional property placed in service after July 31, 1986, and before January 1, 1987. Post-1986 depreciation on property placed in service before 1987 will continue to be computed under the method used when the property was placed in service.

Sage FAS 50/100/200 Asset Accounting provides three standard MACRS depreciation methods: MACRS formula, MACRS table, and Alternative Depreciation System (ADS) straight-line MACRS. A fourth depreciation method, MACRS method MI, permits entry of the shorter recovery periods allowed for qualifying Indian Reservation property. Method MI is available for qualified assets placed in service after 12/31/93 and before 2004.

<top>

ACRS

The Accelerated Cost Recovery System (ACRS) is an IRS-prescribed method for recovering the cost of personal and real property placed in service from 1981 through 1986. ACRS is a modification of the Asset Depreciation Range (ADR) method used in the 1970s. It was created by the Economic Recovery Tax Act of 1981, which required the use of ACRS or alternate ACRS for assets placed in service from 1981 through July 1986. ACRS may have been elected for qualifying assets through December 31, 1986. For tax purposes, assets acquired after 1986 (other than transitional property) must use one of the MACRS methods.

Sage FAS 50/100/500 Asset Accounting supports three ACRS methods: ACRS table; straight-line, alternate ACRS formula; and straight-line, alternate ACRS table. The two straight-line, alternate ACRS methods are essentially the same, except that rounding in the IRS tables produces small differences from the formula calculation in the recovery amount per period.

<top>

STRAIGHT-LINE

The straight-line method is the simplest and most commonly used method for calculating depreciation. It can be used for any depreciable property, but it is not generally allowed for ACRS or MACRS property, which for tax purposes must use ADS straight-line MACRS (method AD) or straight-line, alternate ACRS (methods SA and ST) for straight-line treatment. Under the straight-line depreciation method, the basis of the asset is written off evenly over the useful life of the asset. The same amount of depreciation is taken each year.

The straight-line method is approved under Generally Accepted Accounting Principles (GAAP) and is frequently used for internal books. In general, the amount of depreciation equals an asset's depreciable basis divided by its estimated life.

Sage FAS 50/100/500 Asset Accounting supports four standard straight-line methods, each using a different averaging convention.

<top>

ADS STRAIGHT-LINE

Under the Tax Reform Act of 1986, the Alternative Depreciation System (ADS) straight-line MACRS method replaces the straight-line, alternate ACRS formula and table methods (methods SA and ST) for assets acquired after 1986. ADS is a straight-line method that combines the features of straight-line and MACRS depreciation. Under this method, costs are recovered evenly over recovery periods that are as long as or longer than recovery periods prescribed under MACRS.

You must use ADS straight-line for certain property (property located outside the United States, property used for tax-exempt purposes, and others). Businesses that do not want to take advantage of accelerated depreciation in the early years of an asset's life can use this method. You make the ADS election year by year, but for personal property you must make it for all properties of the same class acquired during the year. For real property, you can elect ADS on a property-by-property basis.

<top>

ACRS STRAIGHT-LINE

As its name implies, straight-line, alternate ACRS depreciation combines features of straight-line and regular ACRS table depreciation.

Like straight-line depreciation, the alternate straight-line method yields a uniform yearly depreciation amount. Whereas straight-line depreciation is based on the estimated life of the asset, alternate straight-line depreciation uses specific recovery periods (defined by law) similar to those used by ACRS table depreciation.

Under the federal tax law, if you use the alternate straight-line method for a personal property asset, you must apply the alternate straight-line method to all assets of the same class placed in service in the same tax year. You can use a different method for assets of the same class in the next year or for assets of a different class in the same tax year. This rule does not apply to real property. For real property, you choose a depreciation method on a property-by-property basis, not on a class-by-class basis.

The system can calculate straight-line, alternate ACRS depreciation either by using a formula that divides the asset's basis by its recovery period or by using IRS tables. The difference between the two methods in the recovery amount per period is due to rounding in the tables.

<top>

DECLINING BALANCE

Declining-balance depreciation is a method that depreciates an asset at a higher rate in the earlier years of the asset's life than straight-line depreciation. It applies only to tangible assets with a useful life equal to or greater than 3 years. According to tax law, for new assets placed in service from 1954 through 1980, declining-balance rates were allowed to a maximum of twice the straight-line rate (200%). When you enter a declining-balance method, you select the rate you want to apply.

Using declining-balance depreciation for each year of an asset's life never completely depreciates the asset. Therefore, the IRS lets you switch from declining-balance depreciation to straight-line depreciation once during the life of an asset. This switch is one of few changes in depreciation method that you can make without special IRS approval.

Sage FAS 50/100/500 Asset Accounting provides six standard declining-balance methods. When paired with the four possible depreciation rates (125%, 150%, 175%, and 200%), you have 24 choices.

Each method is different based on the percentage used, the averaging convention used, and whether it will switch from declining-balance to straight-line at the optimal point. The optimal point for switching to straight-line depreciation is when the deductions allowed by the straight-line method equal or exceed the deductions allowed by the declining-balance method. When the change to straight-line is made, the unrecovered basis of the asset is spread over the remaining estimated life, ensuring that the entire amount is depreciated. When straight-line depreciation is applied in this way, it is often called remaining value over remaining life depreciation. The methods are as follows:

DB Declining-balance, midmonth convention, switch to SL when optimal.
DC Declining-balance, midmonth convention, no switch to SL.
DD Declining-balance, modified half-year, switch to SL when optimal.
DE Declining-balance, modified half-year, no switch to SL.
DH Declining-balance, half-year, switch to SL when optimal.
DI Declining-balance, half-year, no switch to SL.

<top>

SUM OF THE YEARS DIGITS

Sum-of-the-years'-digits depreciation is another way to accelerate the depreciation of an asset. It can result in deductions that are larger than those given by double declining-balance depreciation in the early years. Although the deductions get smaller each year, all of the asset's depreciable basis is written off over the property's useful life. It applies only to tangible assets with a useful life equal to or greater than 3 years.

For the Tax book, sum-of-the-years'-digits depreciation is normally used only for assets placed in service before 1981.

Sage FAS 50/100/500 Asset Accounting provides three standard sum-of-the-years'-digits depreciation methods, each using a different averaging convention:

• Midmonth
• Half-year
• Modified half-year

<top>

REMAINING VALUE OVER REMAINING LIFE

Remaining value over remaining life is similar to straight-line depreciation. What makes it unique is that while the straight-line calculation is static, the remaining value over remaining life calculation is dynamic. If there is a change in a critical value (for example, the asset's estimated life), the straight-line method cannot adjust its future calculations so that the asset is fully depreciated at the end of its life. The remaining value over remaining life method, on the other hand, takes the asset's remaining depreciable basis and depreciates that amount evenly over the asset's remaining estimated life.

Converting to remaining value over remaining life is generally the best way to take an adjustment evenly over the rest of an asset's life. It is the suggested approach to handling a change in an accounting estimate under the Accounting Principles Board (APB) Opinion Number 20.

You can convert from any other depreciation method to the remaining value over remaining life method. To do this, follow these steps:

1. Calculate depreciation through the date that the conversion to remaining value over remaining life is to be effective.

2. Change the Depreciation Method field selection to RV. The system displays a confirmation message.

3. Click the Yes button to confirm that you want the system to reset depreciation. The system displays a message asking if you want to update the beginning depreciation fields with the current depreciation amounts, or clear both the beginning and current depreciation.

If you click the Yes button, the system saves the current depreciation information as beginning depreciation. If you click the No button, the system resets depreciation to zero.

If you change to remaining life in the Tax book, carefully consider the implications of replacing the information in the other books with new defaults before you respond to the prompt concerning changes to the Tax book. Generally, you should respond No.

If you choose the remaining value over remaining life method for an asset in the year you placed the asset in service, and if you placed the asset in service on or before the 15th of the month, the depreciation calculated is identical to that calculated using the straight-line method.

<top>

AVERAGING CONVENTIONS

To avoid the complications of depreciating each asset from the specific date on which you placed it in service, the IRS and GAAP support guidelines that you place assume various assets in service or dispose of them at designated dates throughout the year. These guidelines are called averaging conventions. By assuming an average placed-in-service date, the amount of total depreciation allowed for all assets approximates the total depreciation that would be calculated based on the actual days in service.

Under GAAP and IRS rules, different depreciation methods use specific averaging conventions. See depreciation methods to learn which averaging convention it uses.

There are five averaging conventions:

1. Half-Year Convention
2. Modified Half-Year Convention
3. Midmonth Convention
4. Full-Month Convention
5. Midquarter Convention

<top>

CONVENTION TYPES

HALF-YEAR
Under the half-year convention, you treat an asset as though you placed it in service or disposed of it on July 1 (or on the first day of the 7th month of a fiscal year). One-half of a full year's depreciation is allowed for the asset in its first year placed in service, regardless of when you actually placed it in service during that year.

Under earlier legislation, personal property placed in service before 1987 and depreciated under the ACRS tables used the half-year convention in the year of acquisition. Such personal property was entitled to no depreciation in the year you disposed of it. The MACRS rules of the 1986 Tax Reform Act keep the half-year averaging in the year of acquisition, but they also generally allow for a half-year of depreciation in the year of disposition.

Note: The half-year convention can be used for all MACRS property except residential rental and nonresidential real property. It is used for MACRS 3-, 5-, 7-, 10-, 15-, 20-, and 25-year property (unless the midquarter convention applies).

MODIFIED HALF-YEAR
Under this convention, assets placed in service during the first half of the year are considered to have been placed in service on the first day of the year. Therefore, they receive a full year's depreciation in the acquisition year. Assets placed in service during the second half of the year are considered to have been placed in service on the first day of the following year. Therefore, they receive no depreciation in the acquisition year but receive a full year's depreciation in the subsequent year.

Applying the modified half-year convention in the disposal year is slightly more complicated because the disposal-year allowance depends on the acquisition year allowance. The following table summarizes the relationships:

If Asset Was Placed in Service in the: And Disposed of in the: Amount of Depreciation Allowed in the Disposal Year
1st half of year 1st half of year No depreciation
1st half of year 2nd half of year 50% of full year depreciation
2nd half of year 1st half of year 50% of full year depreciation
2nd half of year 2nd half of year* Full year of depreciation
* To earn the full year of depreciation, the disposal must have been in a year after the acquisition year.

If you are adopting the modified half-year for a vintage account, you should adopt it for all additions and all extraordinary retirements.

MIDMONTH
For ACRS and MACRS real property: A midmonth convention applies to ACRS real property placed in service after June 22, 1984, and to MACRS residential rental and nonresidential real property (that is, 27.5-, 31.5-, and 39-year property). Such property is treated as though it were placed in service or disposed of in the middle of the month. A half-month's depreciation is allowed both in the month of acquisition and in the month of disposition.

For nonrecovery property: A different midmonth convention applies to assets depreciated by methods other than ACRS and MACRS. For these methods, if you place the asset in service after the 15th of the month, no depreciation is taken for that month. If you place the asset in service before the 16th of the month, a full month's depreciation is allowed. Similarly, if you dispose of the asset before the 16th of the month, no depreciation is taken for that month. If you dispose of the asset after the 15th of the month, a full month's depreciation is allowed.

FULL-MONTH
Under a full-month convention, property placed in service at any time during a given month is treated as if it had been placed in service on the first of that month. This allows you to take depreciation for the entire month in which you place the asset in service. If you dispose of the property before the end of the recovery period, no depreciation is allowed for the month in which you dispose of the property.

MIDQUARTER
The Tax Reform Act of 1986 created a midquarter convention to be used if more than 40% of the aggregate depreciable basis of newly acquired qualifying MACRS property (generally, personal property) is placed in service during the last three months of a tax year. Under this midquarter convention, MACRS personal property is treated as though you placed it in service in the middle of the quarter in which you purchased it.

The midquarter convention is optional for the 2001 tax year if September 11, 2001 occurs in the third or fourth quarter of your fiscal year. Pursuant to IRS Notice 2001-70 and 2001-74, you can elect to use the half-year convention, even if more than 40% of the aggregate depreciable basis of newly acquired qualifying MACRS property was placed in service in the last three months of the tax year.

To make the half-year convention election when you would otherwise be required to use the midquarter convention, write "Election Pursuant to Notice 2001-70" across the top of Form 4562, Depreciation and Amortization. You can tell the system to write this text on the form when you complete the Form 4562 report definition dialog box.

Note: When applicable, the midquarter convention can be used for all MACRS property except residential rental and nonresidential real property. It is used for MACRS 3-, 5-, 7-, 10-, 15-, 20-, and 25-year property (unless the half-year convention applies).

<top>