The Heart is an amazing organ

Specialty of heart over other organs

 Cardiovascular system is one of the first forms in embryo.

 The heart cells are special and they form the heart and pulsate.
 No other cells have this life force.
 The heart is 5,000 times stronger than brain.
 The heart has a brain of its own, an organized network of nerve cells (it has
intelligence and build wisdom – giving direction).
 One can be brain-dead but still alive by heart.
 Every cell in the body is permeated with the life force from the heart.
 The heart has spiritual and physical sight.

New findings on the power of heart

 The electromagnetic field has been measured to 3-4 feet from the body. So,
there is a surrounding field.
 It has light-based energy surrounding all the individuals, and
 In a sense emotions (love, affection, anger, etc.) can affect the field.

Ancient concept of the heart and intention (ni‟at)

  The ancient Egyptian believed that judgment in the hereafter will happen
beginning with the heart, weighed against a feather.
 Rasulullah (saw) said “the place of intention is the heart”.
 So, we should have a clean and sound heart.

Surah Al-Hajj (The Pilgrimage) 22:46. Have they not travelled through the
land, and have they hearts wherewith to understand and ears wherewith to hear?
Verily, it is not the eyes that grow blind, but it is the hearts which are in the
breasts that grow blind.

Depreciation methods and Income tax

Depreciation is the reduction/decrease in value of an asset (before tax) over the

time. Several meanings:
1. Decrease in value: generally used term. Irrespective of causes the difference
in values between two different times.
Depreciation = value at an earlier date – value at a later date.
Value could have either of the two meanings: market value and value to the
owner.
2. Amortized cost: accounting concept of depreciation. It is cost, not value.
Prepaid operating cost/expense to be apportioned among the years of life in
a systematic manner. Book value = diff between the cost of an asset and the
total of the depreciation charges made to that date = unamortized cost.

3. Difference in value between an existing old asset and a hypothetical new

asset taken as a standard comparison: appraisal concept based on
replacement cost.
4. Impaired serviceableness: impaired by decay or corrosion, unable to hold
close tolerances as when an asset was new. So, impaired functional
efficiency.

Purpose of depreciation
 Recovering capital in income-producing assets by charging depreciation
against current income.
 Depreciation charges and regular operating costs deducted from gross
income to calculate tax. So, find after-tax worth of a proposal.
Depreciation charges are not actual cash flows. It is not about true decrease in
market value. For all assets taken together, depreciation represents capital
consumption.

Causes of declining value

 Physical depreciation wear-and-tear
 Functional depreciation - use beyond capacity
 Technological depreciation – technological growth
 Sudden failure
 Depletion consumption of exhaustible natural resources to produce products
or services
 Monetary depreciation

Terminology
 Adjusted (cost) basis – original cost of an asset, adjusted by allowable
increase or decrease. It is used to compute depreciation or depletion
deductions.
 First cost or unadjusted basis or simply basis – initial installed cost of an
asset (purchase price + delivery and installation charges + other depreciable
cost) to make asset ready for use.
 Book value – worth of a depreciable asset as recorded. Or, remaining or
undepreciated value after the total amount of depreciated charges up to a
date is subtracted. Done in each end-of-year.
 Recovery period – depreciable life of the asset in years.
 Market value – (estimated) value of the asset at any point of time.
 Depreciation rate or recovery rate – fraction or percentage of first cost put
aside by depreciation each year. It may be same in each year or different.
 Salvage value – estimated market value at the end of useful life of an asset.
Positive, zero or negative.
 Personal property – income-producing tangible items such as vehicles,
manufacturing equipment, material handling devices, computersand office
furniture, etc. depreciation is allowed.
 Real property – real estate such as office building, manufacturing structures,
warehouses, apartments, and so on. Land too but it is not depreciable.
 Half-year convention – an asset is deployed in service or disposed of in
„midyear‟. But the event/s can actually occur anytime during the year. Or,
midmonth, midquarter conventions.

Depreciation Methods
a. Straight-line (SL) method
Simplest. Constant or same amount is depreciated each year over useful full
service life. Diagram below.
Depreciation rate is
SL rate = (100% - estimated salvage percentage)/estimated service life in
years.

Depreciated amount in yr t is then total/cumulative depreciation

And book value

Where B is cost basis (including allowable adjustments), Sn is salvage value
at the end of year n.
Book value

Example
Consider a piece of equipment that costs $25,000 with an estimated useful life of 8
years and a $0 salvage value. The depreciation expense per year for this equipment
would be as follows:
Depreciation Expense = ($25,000 – $0) / 8 = $3,125 per year

Ex. A new equipment, cost basis Tk40,000, 10-year depreciable life. Estimated S is
zero. Prepare a table on annual depreciation amounts and BV at the end of each
year.
Sample calculations:

EoY, t 0 1 2 3 4 5 6 7 8 9 10
dt - 4k 4k 4k 4k 4k 4k 4k 4k 4k 4k
- 4k 8k 12k
BVt 40k 36k

Draw the BV vs time diagram.

Accelerated Models or Accelerated cost recovery system (ACRS):
b. Declining balance (DB) or constant percentage method or Matheson formula
An accelerated write-off model. BV decreases to zero or S, more rapidly than SL
method.
Annual cost of depreciation is a fixed % of BV at the beginning of „the‟ year. If it
is 15%, it is taken as 0.15 BV of the beginning of that yr. So, depreciation charge is
largest in yr 1 and successively decrease.
Ratio of depreciation to BV at the beginning of the year is constant.
(straight line rate). (twice or 200% (max %)of SL rate, also known as
DDB).
For an asset of n = 10 yrs, SL recovery is 1/n = 1/10 and DDB is 2/10 or 20% of
BV.
Actual depreciation rate for each year relative to the first cost is

Diagram shown below.

or

What about S? If BV reaches the estimated S before yr n, what about depreciation

charge?
Can BV be zero at the end of yr n?
Implied
Also, implied r (uniform depreciation rate) using an estimate S. Implied
( )

Example

Consider a piece of property, plant, and equipment (PP&E) that costs $25,000,
with an estimated useful life of 8 years and a $2,500 salvage value. To calculate
the double-declining balance depreciation, set up a schedule:
The information on the schedule is explained below:

1. The beginning book value of the asset is filled in at the beginning of year 1
and the salvage value is filled in at the end of year 8.
2. The rate of depreciation (Rate) is calculated as follows:

Expense = (100% / Useful life of asset) x 2

Expense = (100% / 8) x 2 = 25%

Since this is a double-declining method, we multiply the rate of depreciation by 2.

3. Multiply the rate of depreciation by the beginning book value to determine the
expense for that year. For example, $25,000 x 25% = $6,250 depreciation expense.

4. Subtract the expense from the beginning book value to arrive at the ending book
value. For example, $25,000 – $6,250 = $18,750 ending book value at the end of
the first year.

5. The ending book value for that year is the beginning book value for the
following year. For example, the year 1 ending book value of $18,750 would be
the year 2 beginning book value. Repeat this until the last year of useful life.
 Ex. When r = 2/n (DDB) and r = 1.5/n (DB)
tabulate on annual depreciation
amounts and BV at the end of each year for the equipment given in the previous
exercise.
Sample calculations:
When r = 2/n = 2/10 = 0.2

EoY, t 0 1 2 3 4 5 6 7 8 9 10
dt -

BVt 40k

When r = 1.5/n

EoY, t 0 1 2 3 4 5 6 7 8 9 10
dt -

BVt 40k
Modified Accelerated Cost Recovery system/ Method (MACRS)
Assumes that S would be zero, even though this may have a positive value. Annual
depreciation
Book value
Book value can also be obtained by subtracting the total depreciation for year 1
through (t – 1) from the first cost. That is,
Book value = first cost – sum of accumulated depreciation

Depreciation rates, r, applied to the first cost B for the MACRS method
Depreciation rate (%) for each MACRS recovery period in years
Year 3-year 5-year 7-year 10-year 15-year 20-year
1 33.33 20.00 14.29 10.00 5.00 3.75
2 44.45 32.00 24.49 18.00 9.50 7.22
3 14.81 19.20 17.49 14.40 8.55 6.68
4 7.41 11.52 12.49 11.52 7.70 6.18
5 11.52 8.93 9.22 6.93 5.71
6 5.76 8.92 7.37 6.23 5.29
7 8.93 6.55 5.90 4.89
8 4.46 6.55 5.90 4.52
9 6.55 5.90 4.46
10 6.55 5.90 4.46
11 3.28 5.91 4.46
12 5.90 4.46
13 5.91 4.46
14 5.90 4.46
15 5.91 4.46
16 2.95 4.46
17-20 4.46
21 2.23

MACRS method include DDB method (r = 2/n) and switch to SL during recovery
period. MACRS rates usually start with this DDB rate and switch to SL (r =1/n),
when SL offers a faster write-off.
Ex. Initial cost of an asset is $400,000. Estimated S after 3 years is expected to be
6% of the first cost. Compare depreciation for 3-year MACRS and DDB. What
would be total depreciation over the next 2 years? Which model offers larger total
depreciation after 2 years? BV for each model after 2 years and at the end of
recovery period.

Solution:
B = 400,000, estimated S = 0.06(400,000) = 24,000
MACRS rate for n = 3 from table and depreciation rate for DDB r = 2/3 = 0.6667
(max).

MACRS DDB
Year Rate Depreciation Book Depreciation Book
value value
0 - 0 400K - 400K
1 0.3333 133,320 266,680 266,667 133,333
2 .4445 177,800 88,88 88,889 44,444
3 .1481 59,240 29,640 24,444 20,000
4 .0741 29,640 0

The 2-yr total accumulated depreciation values from this table are:
MACRS 133,320 + 177,800 = 311,120
DDB 266,667 + 88,889 = 355,556. (greater)
After 2 years, BV for DDB at 44,444 is 50% of MACRS BV of 88,880.

c. Sum-of-years-digits (SYD) method

Find the cumulative of the years up to the year of life. Put these years in
reverse order and follow the table below|:
Year, t No. of the yr in reverse SYD depreciation factor
order
1 5 5/15
2 4 4/15
3 3 3/15
4 2
5 1
 Total 15

Depreciation for year t,

[ ]
The BV at the end of yr t:
* + * +
Cumulative depreciation through the tth yr is:

Example

Consider a piece of equipment that costs $25,000 and has an estimated useful life
of 8 years and a $0 salvage value. To calculate the sum-of-the-years-digits
depreciation, set up a schedule:

The information in the schedule is explained below:

1. The depreciation base is constant throughout the years and is calculated as

follows:

Depreciation Base = Cost – Salvage value

Depreciation Base = $25,000 – $0 = $25,000

2. The remaining life is simply the remaining life of the asset. For example, at the
beginning of the year, the asset has a remaining life of 8 years. The following year,
the asset has a remaining life of 7 years, etc.
3. RL / SYD is “remaining life divided by sum of the years.” In this example, the
asset has a useful life of 8 years. Therefore, the sum of the years would be 1 + 2 +
3 + 4 + 5 + 6 + 7 + 8 = 36 years. The remaining life in the beginning of year 1 is 8.
Therefore, the RM / SYD = 8 / 36 = 0.2222.

4. The RL / SYD number is multiplied by the depreciating base to determine the

expense for that year.

5. The same is done for the following years. In the beginning of year 2, RL / SYD
would be 7 / 36 = 0.1944. 0.1944 x $25,000 = $4,861 expense for year 2.

Ex. Use the past info. Tabulate the annual depreciation amount and book value for
each year. See the difference/s.
Sample calculations:

EoY, t 0 1 2 3 4 5 6 7 8 9 10
dt -

BVt 40k
 Suppose Coronavirus is no more! Fine!
BUT IF THERE IS NO OXYGEN ON EARTH FOR 2 MINUTES????

d. Units-of-production method
If decreasing in value of the asset is mainly a function of use (not time), we need a
different method.

Example
Consider a machine that costs $25,000, with an estimated total unit production of
100 million and a $0 salvage value. During the first quarter of activity, the machine
produced 4 million units.

To calculate the depreciation expense using the formula above:

Depreciation Expense = (4 million / 100 million) x ($25,000 – $0) = $1,000
Ex. Say cost basis is 50,000 and expected S = 10,000, when replaced after 30,000
hours of use. Find the depreciation rate per hour of use, and book value after
10,000 hours of operation.

Here is a summary of the depreciation expense over time for each of the 4 types of
expense.
Microsoft Excel solution

e. Switching between depreciation models

For accelerated BV reduction, maximization of of PV of accumulated and
total depreciation over the recovery period. Take tax advantage in some years.
DB/DDB with switchover to SL- common
You might have observed that DB method never reaches a BV of zero. Then at
certain point of time switch to SL method and make S zero or to a desired value.
Rules of switching:
i. It is recommended when depreciation for yr t by used method is less than a
new method.
ii. BV for any method can be > or = to Sestimated (zero). Switching within
MACRS always estimate S = 0.
iii. BVt is used as new adjusted basis to selected larger dt for the next switching
decision.
iv. When switching from DB model, the estimated S, not DB implied S, is used
to compute the depreciation for the new method.
v. Only one switch can take place during the recovery period.

Ex. Use past data/info.

Depreciation method
Year (2) (3) (4) (5)
Beginning of yr 200% DB SL method Depreciation
BV method amount selected
1 40,000
2
3
4
5
6
7
8
9
10

Maximizing PV/PW in all situations

∑ ( )

A comprehensive Exercise on depreciation

A new bus costs $85,000 trade in with an old bus. BV of the old bus at the time of
trade-in is $10,000. Estimated new bus life is 10 years and its salvage value
$5,000.
Apply MACRS general depreciation system (GDS). Find PW at time zero of
depreciation methods when MARR is 10%.

Solution:
Cost basis is $85,000 + $ 10,000 = $95,000. Based on a Table available in book,
Assest class is 00.23, class-life is 9 years, GDS is 5 years. So, for SL, DDB, and
SYD methods, asset life will be considered 9 years, not 10 years.
SL Method:
EOL, t dt BVt
0 - $95,000
1 10,000 Continue
2 Same
3 Continue
4 …
5 …
6
7
8
9 $5,000

DDB Method
 EOL, t dt BVt
0 - $95,000
1 21,111 73,889
2 Same % Continue
3 Continue
4 …
5 …
6
7
8
9

SYD method
EOL, t No. of yr in SYD dt=(B- BVt
reverse order depreciation S)factor
factor
0 - - - $95,000
1 9 9/45 18,000 77,000
2 8 8/45 continue Continue
3 7 So on
4 6
5 5
6 4
7 3
8 2
9 1
$5,000
DDB with switch to SL method
DDB never reach to zero BV, so switch to SL will be made to ensure a BV of
5000 when n = 9 years (class life)
EOL, t Beginning of DDB method SL Depreciation
yr BV depreciation depreciation amount
(BV9 = 5,000) selected
(higher)
 1 95,000 21,111 10,000 21,111
2 continue continue 8,611
3 Continue
4
5
6
7
8
9

MACRS (GDS) with half-life convention

Bus is now sold in yr 5
EOL, t Factor dt BVt
(Table)
0 - - $95,000
1 0.2000 19,000 76,000
2 0.3200 30,400 Continue
3 0.1920 18,240
4 0.1152 10,944
5 0.0576 5,472

Depletion method
Only to natural resources (mines, wells, quarries, forests, etc.). Removed resources
cannot be replaced but exhausted. Examples are oil, minerals and timber.
Depletion reduces a company's taxable income. Two methods:
 Cost depletion, and
 Percentage depletion.
A profitable company chooses the method which results in the greater depletion
allowance. However, only cost depletion may be used for timber or for major oil
and gas wells.
Depletion rate = cost of resource rights / estimated resource units
dt = (depletion rate)(units removed in year t)
Net income = Gross income - (all expenses except depletion)
Cost/factor depletion based on level of usage (not time).
Cost depletion factor for yr t is
Accumulated such depletion cannot exceed the total first cost of the resource.
Ex. XY co would cut timber for $500,000. An estimated 200 million board feet of
lumber are harvestable.
i. Determine the depletion amount for the first 2 years if 20 million and 25
million board feet are removed.
ii. If, after 2 years total removable board feet is re-estimated to be 250 million
from time t = 0, compute the new cost-depletion factor for years 3 and later.

Depletion for the period = (amount extracted/total extractable amount)x cost of

extraction
Calculate depletion charge for the period
First let‟s calculate the cost:
(000)
Land 1,000
Survey fee 250
Site preparation 100
Plantation 200
Total cost 1,550
As there is no scrap value therefore, depreciable value is 1.55 million. In this
period, 200,000 mcf is extracted out of 10 million. Therefore depletion charge can
be calculated as follows:
Depletion for the period 200,000
x 1,550,000
= 10,000,000
Depletion for the period = $31,000

 Percentage depletion. This cannot be used for timber or major oil and gas
wells.
Annual depletion amount calculated as:
Procedure for Percentage Depletion. Percentage depletion amount = constant
percentage x gross income from property
dt = (% rate*) (gross income in year t).
*This is a defined rate based on the resource. The % rates for various resources are
often given in engineering economic analysis textbooks.
However, dt cannot exceed 50% of net or taxable income. This ceiling applies to
the percentage method only.