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

Answer 1

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.